Chapter 15 of Wilmott’s book introduces the binomial model, and honestly it might be the single most important chapter for building intuition about how option pricing actually works. Forget stochastic calculus for a moment. This model uses nothing more than basic arithmetic, and yet it arrives at exactly the same answers as Black-Scholes.
Wilmott calls Chapter 5 “without doubt, the most important chapter in the book.” He is not exaggerating. Everything before this was setup. Everything after this builds on what happens here. The Black-Scholes equation was first written down in 1969, the derivation was published in 1973, and finance has never been the same since.
I’m about to do something a bit ambitious. I’m going to retell the entire “Paul Wilmott on Quantitative Finance” - one of the biggest, most comprehensive textbooks on quantitative finance ever written. And I’m going to do it in plain English.
Book: Financial Markets and Institutions, 11th Edition Author: Jeff Madura Publisher: Cengage Learning, 2015 Series: Chapter 14 Review
Options give you the right, but not the obligation, to buy or sell something at a specific price by a specific date. That “not the obligation” part is what makes them different from futures. Chapter 14 covers call options, put options, what drives their prices, and how they are used to speculate and hedge.
This is Part 2 of our retelling of Chapter 2 from “Trading the Fixed Income, Inflation and Credit Markets: A Relative Value Guide” by Neil C. Schofield and Troy Bowler (Wiley, 2011, ISBN: 978-0-470-74229-7).