Introduction to Option Pricing

Abstract

In the previous chapters we have prepared mathematical tools that allow us to model in continuous time the dynamics of financial securities, for instance, stocks. Now, we shall study prices of derived financial securities. A derivative security, for instance an option, is a financial instrument whose value is dependent upon the values of an underlying more fundamental security. In this chapter we give an introduction into derivatives, in particular, European options. For simplicity, we focus our discussion on options under the BS model. Furthermore, we introduce at the end of the chapter important results on squared Bessel processes because these will be crucial for the understanding of the following chapters.