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(ii) Discuss the other relevant alternatives of the BSM approach on the Stock Market of Market....

(ii) Discuss the other relevant alternatives of the BSM approach on the Stock Market of Market.

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Answer #1

Relevant alternatives to the Black Sholes Model approach of option pricing:

1. Monte Carlo Simulation- more sophisticated method than the BSM, it simulates possible future stock prices and then find the discounted expected option payoffs. There are 2 scenarios involved: simulation with multiple periods and simulation in continuous time.

2. Option pricing using a Time series: this involves 3 steps; calculating probabilities to estimate the future movements of stock prices, for each outcome of the binomial distribution, calculate the value of option as MAX( forecasted stock price, exercise price, 0) and calculating the price of the option as the sum.

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