Simple Heuristics on the Black-Scholes Option Pricing Model Rossitsa Yalamova University of Lethbridge

Objective and Goal Develop passion for creative solution and intuition of the variables relationships in the model Develop instructional design and educational technology for the foundations of derivative valuation and the basic principles of risk management and hedging.

Problem Solving Algorithms do not necessarily lead to comprehension but promise a solution, while heuristics are understood but do not always guarantee solutions. PDE for the solution of the BSOPM

The Black-Scholes model:

Concrete example technique Option at the money (S=K) risk free rate is 0:

Option at the money (S=K); R=0 T=1; σ=0.8

(S=K); risk free rate positive Risk free rate moves the area to the right by and increases the value as K is discounted

Adding positive instantaneous return (S>K) The moves to the right by

Option “out-of-the-money”; r=0 The area moves to the left by

Option “out-of-the-money”; r>0

Implied volatility

Volatility Smiles

Portfolio Insurance Protective put  S=56; P=2.38, K=50  Short position in the stock and long in the risk free asset  W s =SN(d1)/(S+P)