Financial Mathematics Text

Monday, June 30, 2014

The Expected Return of a Put Option

In my previous post, I explored The Expected Return of a Call Option by assuming that stock price returns follow a normal distribution. I then looked at some attributes of the distribution of option returns under that assumption.

Today I'll apply the same technique to put options.

Thursday, June 26, 2014

Some Recent Updates to AF2P

So I've made some changes recently. Here's a quick overview of some of the changes (feedback welcome).


So I've changed the color scheme a bit. It looks different (better?) Take it for what it's worth (probably not much; I'm pretty lazy when it comes to aesthetics.)

Share Buttons

I've changed the share buttons a bit. If any of them don't work let me know.


These are located beneath the share buttons. They allows you to check a "reaction" to a blog without responding. If you have ideas on more reactions you'd like to see, let me know and I'll consider adding them. (I wanted to add something like "garbage" but I wanted to use a better term than "garbage". Feel free to offer suggestions.


So I was recently informed that my comments section was restricted to those only with a blogger account. While I still want to avoid anonymous posters, I did expand the reach a bit. You can now respond with a blogger, WordPress, AIM (1990's anyone?), LiveJournal, TypePad or OpenID account. The latter should open up many options including Google and Yahoo accounts (see here.)

Subscription Options

There are a variety of subscription options. You can still use feedburner which allows you to subscribe via any RSS feeder or email. In addition, my twitter and facebook page auto-post items from feedburner so following either of those would suffice as well.

Monday, June 23, 2014

The Expected Return of a Call Option

If I were to buy a call option, what return should I expect to get? Is it worth buying? Or is it a losing proposition?

Today I hope to address this question from one angle. What does standard finance theory actually have to say about the matter?

Now of course standard finance theory may very well be wrong. Some of the assumptions that will be used today are problematic.

As it turns out, this presentation will be a sort of a proof by contradiction. I believe it will show that standard finance theory is inconsistent. Or at a minimum, certain propositions that are often assumed in various financial models are incompatible depending upon interpretation.

While my interest in this is somewhat academic (aren't all of my interests?) there may be a practical application to this which has to do with estimating the cost of equity. It may be possible to use this device as an alternative method of determining cost of equity (say, versus the lousy CAPM model.)

But that will have to be worked out some other time. Today I just want to show how one can calculate the expected return on a call option.

Sunday, June 15, 2014

Real Estate: The Better Inflation Hedge

In my previous post, I discussed having a healthy dose of skepticism when one sees a correlation between two variables. The relationship may not hold very well out of sample (such as future performance).

But I also discussed gold as an inflation hedge and I suggested that gold was a lousy inflation hedge in spite of what most people seem to believe.

Today I want to discuss another asset class which, although may or may not be a good inflation hedge, is nonetheless a better inflation hedge than gold. Furthermore, this asset class has many other attractive features that suggest it should be pursued before gold if you're looking for a hedge against inflation.

Monday, June 9, 2014

Gold, Hedges and Correlations

Today I'm going to touch on a sort of theme I have here and that's regarding on how to assess correlated data. How much can we actually read into it? How do we determine that there's a fundamental relationship that, not only holds well in the past but will continue to do so in the future?

To do that I'll be taking a quick look at gold and why I consider the "inflation hedge myth". In short, gold is not an inflation hedge. At least not on any reasonable time scale.

Thursday, June 5, 2014

Relationship between VIX and Credit Spreads

This is motivated by a post from David Merkel of the Aleph Blog, called Buy Stocks When Credit Spreads are High, Sell When They are Low.

Merkel suggests that "credit spreads and implied volatility are cousins. When there is complacency, both are low. When there is panic, both are high."

Monday, June 2, 2014

Exploring Operational Definitions: Part II - Distance

So in Part I, I began discussing operational definitions. In particular, I've been focusing on the concept of distance.

I proposed that we might consider our intuitions regarding answering the question - what is distance? - by means of early experience of operational definitions of distance. The idea being that what we consider distance is going to be closely related to ways we were taught to measure distance.