ABSTRACT
This chapter discusses stock options (also called equity options), which give the holder the right to buy (or to sell) a stock for a specified price during a specified time period. Thus, the buyer of an option has the right, but not the obligation, to buy or sell the stock. A call option gives the right to buy one unit (share) of the underlying stock at the strike price. Financial models can be categorized as either of two general types: continuous-time or discrete-time. To construct a discrete-time financial model one needs to know the initial price and the probability distribution of one-period returns for each base asset. The chapter provides a brief introduction to the concept of a self-financing trading strategy within the binomial model. The binomial tree model has apparent disadvantages as a discrete-time and discrete-price model. To distinguish risky and risk-free assets, one needs to take a look at the distribution of their returns.
