Valuing Options

In the last section we determined what options are worth on the expiration date. Now we wish to determine the value of options when you buy them well before expiration.4 We begin by considering the lower and upper bounds on the value of a call.

4Our discussion in this section is of American options, because they are traded in the real world. As necessary, we will indicate differences for European options.

® 1 Ross-Westerfield-Jaffe: I VI. Options, Futures, and I 22. Options and Corporate I I © The McGraw-Hill

Corporate Finance, Sixth Corporate Finance Finance: Basic Concepts Companies, 2002

Edition

Chapter 22 Options and Corporate Finance: Basic Concepts 621

■ FIGURE 22.7 The Upper and Lower Boundaries of Call-Option Values

Value of call prior to expiration date UPPer = Price bound of stock

Value of call prior to expiration date UPPer = Price bound of stock

price

Value of the call must lie in the colored region.

price

Value of the call must lie in the colored region.

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