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Options Pricing using Monte Carlo method
Whether you work in the financial markets or not, you have probably heard of option contracts. These are are slightly more complex than delta one, i.e. financial derivatives which have (or almost) a one-to-one relationship with their underlying assets with regard to price movements. Although the market quotes simpler products in particular, some portfolios either have or are yet to have more sophisticated securities, therefore it would be worthwhile to know their prices when selling or buying them. Pricing is usually determined with some calculation that include mathematical models and/or simulation methods. A popular approach to pricing options is the renowned Monte Carlo method.
What this article covers
- Option contracts basics
- Intuitive approach to Monte Carlo simulation
- Monte Carlo method adaptation to options market
- Black-Scholes dynamics
- Brownian Motion
- Discounted expectation of payoffs
- Random paths simulation, payoff calculation and discounted expectation (Python code)
- Conclusion
Option contracts basics
Options give you the right, but not the obligation, to buy (call contract) or sell…
