Black-Scholes-Merton

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cfa_010203

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Hi everybody,
I am seeing quite a few problems in the CFA curriculum in the options chapter (blue boxes) that are based on Black-Scholes formula. Do we really need to remember it for the exam? Not the final form but rather the formula to calculate d1 and d2.
They don’t even say that it is not going to be tested in the exam- which is what is making me worried. It’s just too much to remember :(
 
No, it is not required. I think they require that before but not this time. Some of the formulas from the CFA book questions will not be shown on the test at least this is what the Kaplan states in the video.
 
You need to know how the (i believe 5) inputs being changed will impact the output
 
Yayyywork wrote:You need to know how the (i believe 5) inputs being changed will impact the output
Click to expand...
Is enough to understand Greeks regarding this?
 
Thanks for your replies, guys! I think in the exam they would give us the values of N(d1) and N(d2) and like that it is not so difficult to use the Black Scholes formula :D
 
Flashback wrote:
Yayyywork wrote:You need to know how the (i believe 5) inputs being changed will impact the output
Click to expand...
Is enough to understand Greeks regarding this?
Click to expand...
No, you ned to know those as well though. You need to know how a change in each input changes option values for a call & put
 
Yayyywork wrote:
Flashback wrote:
Yayyywork wrote:You need to know how the (i believe 5) inputs being changed will impact the output
Click to expand...
Is enough to understand Greeks regarding this?
Click to expand...
No, you ned to know those as well though. You need to know how a change in each input changes option values for a call & put
Click to expand...
Well, the Greeks are the constituents of the BSM so you are talking about the same thing.
 
You need to know what the greeks are, but when it talks about inputs they are talking about, the LOS is pretty clear and the CFAI gives you a giant chart with the effects of these on option price.
-Strike price
-Underlying
-Time to expiration
-Volatility
-Rf
I think there is one more im forgetting
 
The BSM itself is simple. at First, i thought it was such a monster, and i always avoid it with the hope that we would not be asked to calculate it in the exam, but last week, i took a whole day to go through it, and I realize its such a toothless puppy.
You just have to find time and seat down with its, its straightforward and easy to understand.. Now i know the BSM inside out, and can easily calculate it.
 
Simple, just know that the first thing is for you to find d1 and d2.
d1 = [ln(So/X) + {r + (volatility^2)/2}*T] / volatility*T^1/2
then d2 = d1 - volatility*T^1/2.
Then the next step is for you to get the probability value, which will be done by rounding your values for d1 and d2 to 2 decimal numbers, say d1 = 0.52.
then you look up 0.5 under 0.02 to get the probability value, you do the same for d2.
Then you solve for the call and put price.
Call = So*Nd1 - Xe^(-r*T)*Nd2)
Put = Xe^(-r*T)*(1-Nd2) - So*(1-Nd1)
Note: Nd1 and Nd2 are the volatility values you looked up in the table.
Tadaaa… then we are done with the option pricing…
Just be weary that we can have a situation where instead of So which is the spot price, forward price may be used, that is using BSM in a forward pricing where a forward rate is used, in that case, you need to find the PV of the cash flow……e.t.c,
so, Call = e^(-r*T) * [(Ft*Ndi) - (X*Nd2)]
and Put = e^(-r*T) * [X*(1-Nd2) - Ft*(1-Ndi)]
This is because we are trying to discount the forward price back to its pv so as to compare it with the excersice price.
However, you need to be careful in calculating d1, as in this case, we are using the forward or future rate or price, and thus we will have to exclude the continuos compounded rate, because the forward rate or price is already compounded, thus our d1 formula becomes.
d1 = [ln(Ft/X) + ({volatility^2}/2)*T] / volatility*{T^(1/2)}
then d2 remains the same.
We can also apply it to interest rate option…
In fact, for me, the BSM is one of the easiest concept.. cant wait for it to show up in the exam..
lol…. Just take time to go through it, i am sure you will be fine with it.
 
olajideanuoluwa001 wrote:The BSM itself is simple. at First, i thought it was such a monster, and i always avoid it with the hope that we would not be asked to calculate it in the exam, but last week, i took a whole day to go through it, and I realize its such a toothless puppy.
Click to expand...
Puppies, in fact, have very, very sharp teeth.
 
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