In modern finance, the option theory and its applications play an important role. Many trading strategies, corporate incentive plans, and hedging strategies include various types of options. In Chapter 6, Introduction to NumPy and SciPy, we showed that you can write a five-line Python program to price a call option based on the Black-Scholes-Merton option model even without understanding its underlying theory and logic. In this chapter, we will explain the option theory and its related applications in more detail.
In particular, we will cover the following topics:
Payoff and profit/loss functions and their graphical representations of call and put
European versus American options
Normal distribution, standard normal distribution, and cumulative normal distribution
The Black-Scholes-Merton option model with/without dividend
Various trading strategies and their visual presentations, such as covered call, straddle, butterfly, and calendar spread
Delta...