ABSTRACT
Chapter overview: In Part II of this book, we deal with the pricing and hedging of options by prescribing different assumptions on the probabilistic behavior of the underlying asset. The price of the asset can evolve either binomially or continuously in accordance with a lognormal process. Because any option pricing model can be criticized for being subjective and unrealistic to some extent, this begs the question: is there anything definite that one can say about option prices regardless of how the price of the underlying asset develops over time? In such paucity of information, the answer turns out to be affirmative, with a surprisingly rich theory describing how option prices should behave to preclude arbitrage opportunities.
