Question

1. Describe, in great detail, the characteristics of a viable American equity option pricing model. Include detailed discussion of the trades used to exploit the various types of mispricings that could occur in markets.

Answer 1

Characteristics of a viable American equity option pricing model are-

1. Investors can buy and sell the options without actually owning the stock.

2. It gives a right to investors but not an obligation to buy or sell a stock at strike price before the expiry .

3. It requires less margins and it amounts to smaller capital to trade.

4. It provides with buying options for longer time frame so one can stick to his positions.

It could also lead to various type of mispricing as -

A. It involves a lot of speculation and it's no fundamental thing.

B.It can create havoc if volatility spikes beyond a certain limitations.

C. You can hardly maintain a risk reward ratio while option trading. You need a lot of luck. .