D. Option Valuation

1.  Intrinsic vs. time value

• Intrinsic value - payoff if option immediately exercised

• Time value - difference between actual price and intrinsic value

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• Call option valuation function

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2.  Determinants of option value

a.  Stock price (S)

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b.  Exercise price (X)

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c.  Volatility (σ)

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d.  Time to expiration (T)

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e.  Interest rate (r_f)

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f.  Dividend payouts

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3.  Black-Scholes option valuation

a.  Normal distribution

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b.  Call options

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c.  Put options