ABSTRACT
We are now ready to tackle decision options-a general problem that contains multiple interacting options, cash flows, private risks, and other entities. Options pricing theory was invented to price financial options. As we have seen, financial options are single-standing. When they are on assets such as stocks, whose price process follows geometric Brownian motion (GBM), we have a very convenient closed-form solution in the Black-Scholes equation. Both risk-neutral valuation techniques and the Black-Scholes equation rely on the assumption that we can invoke a no-arbitrage condition against a synthetic bundle, formed using the underlying asset and debt, that has the same payoff as the option and the option itself. As we discussed, in an efficient market, assets with the same future payoffs will be priced the same today.
