INTRODUCTION

An option is a contract between two parties, a buyer and a seller, that allows the buyer to buy or sell a particular asset at, or before, a specified time—the expiration time or the date of maturity—at a price agreed on between the buyer and the seller. This agreed price, the price of the stock at which the contract is made, is known as the strike price or exercise price. In exchange for granting the contract, the seller obtains a premium from the buyer. This premium is known as the price of the option. The underlying asset can be a property or a security such as bond, stock etc. The premium generally depends on the strike price, the expiration time and the current price of the asset. One basic assumption in the theory of option pricing is that there is no arbitrage opportunity. An arbitrage opportunity is a trading strategy that allows the possibility of an instantaneous positive profit without any risk (see Chapter 9). The ownership of the contract entitles the buyer to exercise the right to buy or sell the asset. The essential idea is to create markets where these assets can be traded. Thus, an option is a financial derivative that connects the buyer and the seller of an asset at a reference price (the strike price) during a specified time frame (expiration time).