Options Trading Options Pricing and Valuation 1 — Questions and Answers
Question 1: What model is most commonly used to price European-style options?
- Black-Scholes model (Correct answer)
- Binomial tree model
- Monte Carlo simulation
- CAPM model
Correct answer: Black-Scholes model
The Black-Scholes model is the most widely used framework for pricing European-style options based on five key inputs.
Question 2: Which of the following is NOT an input into the Black-Scholes pricing model?
- Expected future return of the stock (Correct answer)
- Current stock price
- Strike price
- Time to expiration
Correct answer: Expected future return of the stock
The Black-Scholes model uses current stock price, strike price, time to expiration, risk-free rate, and implied volatility — not expected future returns.
Question 3: What is 'intrinsic value' of an option?
- The amount the option is in the money (Correct answer)
- The total premium of the option
- The time value of the option
- The implied volatility of the option
Correct answer: The amount the option is in the money
Intrinsic value is the real, tangible value of an option — the difference between the current underlying price and the strike price for in-the-money options.
Question 4: The time value of an option is calculated as:
- Option premium minus intrinsic value (Correct answer)
- Option premium plus intrinsic value
- Strike price minus current price
- Implied volatility times delta
Correct answer: Option premium minus intrinsic value
Time value equals the total option premium minus the intrinsic value, representing the extra amount traders pay for the possibility of future gains.
Question 5: If a call option has a strike price of $100 and the stock is trading at $110, what is the intrinsic value?
- $10 (Correct answer)
- $0
- $110
- $100
Correct answer: $10
The intrinsic value is $110 - $100 = $10, since the call option is $10 in the money.
Question 6: Put-call parity establishes a relationship between:
- Call price, put price, stock price, and present value of strike (Correct answer)
- Delta and gamma of puts and calls
- Vega and theta across different strikes
- Open interest and volume of puts and calls
Correct answer: Call price, put price, stock price, and present value of strike
Put-call parity states that C - P = S - PV(K), linking the prices of calls, puts, the underlying stock, and the present value of the strike price.
Options Trading Options Pricing and Valuation 1
What model is most commonly used to price European-style options?