1. Question 1. What Are Derivatives?

Answer :
Derivatives, such as futures or options, are financial contracts which derive their
value from a spot price, which is called the “underlying”. For example, wheat
farmers may wish to enter into a contract to sell their harvest at a future date to
eliminate the risk of a change in prices by that date. Such a transaction would
take place through a forward or futures market. This market is the “derivatives
market”, and the prices of this market would be driven by the spot market price of
wheat which is the “underlying”. The term “contracts” is often applied to denote
the specific traded instrument, whether it is a derivative contract in wheat, gold or
equity shares. The world over, derivatives are a key part of the fi nancial system.
The most important contract types are futures and options, and the most
important underlying markets are equity, treasury bills, commodities, foreign
exchange, real estate etc.
2. Question 2. What Is A Forward Contract?
Answer :
In a forward contract, two parties agree to do a trade at some future date, at a
stated price and quantity. No money changes hands at the time the deal is signed.

3. Question 3. Why Is Forward Contracting Useful?

Answer :
Forward contracting is very valuable in hedging and speculation. The classic
hedging application would be that of a wheat farmer forward -selling his harvest at
a known price in order to eliminate price risk. Conversely, a bread factory may
want to buy bread forward in order to assist production planning without the risk of
price fl uctuations. If a speculator has information or analysis which forecasts an
upturn in a price, then he can go long on the forward market instead of the cash
market. The speculator would go long on the forward, wait for the price to rise,
and then take a reversing transaction making a profit.
4. Question 4. What Are The Problems Of Forward Markets?
Answer :
Forward markets worldwide are affl icted by several problems:
o lack of centralisation of trading,
o illiquidity, and
o counterparty risk.
In the fi rst two of these, the basic problem is that of too much fl exibility and
generality. The forward market is like the real estate market in that any two
persons can form contracts against each other. This often makes them design
terms of the deal which are very convenient in that specifi c situation for the
specifi c parties, but makes the contracts nontradeable if more participants are
involved. Also the “phone market” here is unlike the centralisation of price
discovery that is obtained on an exchange, resulting in an illiquid market place for
forward markets. Counterparty risk in forward markets is a simple idea: when one
of the two sides of the transaction chooses to declare bankruptcy, the other
suffers. Forward markets have one basic issue: the larger the time period over
which the forward contract is open, the larger are the potential price movements,
and hence the larger is the counter- party risk. Even when forward markets trade
standardized contracts, and hence avoid the problem of illiquidity, the
counterparty risk remains a very real problem.
5. Question 5. What Is A Futures Contract?
Answer :
Futures markets were designed to solve all the three problems (listed in Question
4) of forward markets. Futures markets are exactly like forward markets in terms
of basic economics. However, contracts are standardised and trading is
centralized (on a stock exchange). There is no counterparty risk (thanks to the
institution of a clearing corporation which becomes counterparty to both sides of
each transaction and guarantees the trade). In futures markets, unlike in forward
markets, increasing the time to expiration does not increase the counter party risk.
Futures markets are highly liquid as compared to the forward markets.

6. Question 6. What Are Various Types Of Derivative Instruments Traded At

Nse?
Answer :
There are two types of derivatives instruments traded on NSE; namely
Futures and Options :
Futures : A futures contract is an agreement between two parties to buy or sell an
asset at a certain time in the future at a certain price. All the futures contracts are
settled in cash at NSE.
Options : An Option is a contract which gives the right, but not an obligation, to
buy or sell the underlying at a stated date and at a stated price. While a buyer of
an option pays the premium and buys the right to exercise his option, the writer of
an option is the one who receives the option premium and therefore obliged to
sell/buy the asset if the buyer exercises it on him. Options are of two types - Calls
and Puts options : “Calls” give the buyer the right but not the obligation to buy a
given quantity of the underlying asset, at a given price on or before a given future
date. “Puts” give the buyer the right, but not the obligation to sell a given quantity
of underlying asset at a given price on or before a given future date. All the
options contracts are settled in cash. Further the Options are classifi ed based on
type of exercise. At present the Exercise style can be European or
American. American Option - American options are options contracts that can be
exercised at any time upto the expiration date. Options on individual securities
available at NSE are American type of options.
European Options - European options are options that can be exercised only on
the expiration date. All index options traded at NSE are European Options.
Options contracts like futures are Cash settled at NSE
7. Question 7. What Are Various Products Available For Trading In Futures
And Options Segment At Nse?
Answer :
Futures and options contracts are traded on Indices and on Single stocks. The
derivatives trading at NSE commenced with futures on the Nifty 50 in June 2000.
Subsequently, various other products were introduced and presently futures and
options contracts on the following products are available at NSE: 1. Indices : Nifty
50, CNX IT Index, Bank Nifty Index, CNX Nifty Junior, CNX 100 , Nifty Midcap 50,
Mini Nifty and Long dated Options contracts on Nifty 50. 2. Single stocks - 228

8. Question 8. Why Should I Trade In Derivatives?

Answer :
Futures trading will be of interest to those who wish to:
 o Invest - take a view on the market and buy or sell accordingly.
o Price Risk Transfer- Hedging - Hedging is buying and selling futures
contracts to offset the risks of changing underlying market prices. Thus it
helps in reducing the risk associated with exposures in underlying
market by taking a counter- positions in the futures market. For example,
an investor who has purchased a portfolio of stocks may have a fear of
adverse market conditions in future which may reduce the value of his
portfolio. He can hedge against this risk by shorting the index which is
correlated with his portfolio, say the Nifty 50. In case the markets fall, he
would make a profi t by squaring off his short Nifty 50 position. This profi
t would compensate for the loss he suffers in his portfolio as a result of
the fall in the markets.
o Leverage- Since the investor is required to pay a small fraction of the
value of the total contract as margins, trading in Futures is a leveraged
activity since the investor is able to control the total value of the contract
with a relatively small amount of margin. Thus the Leverage enables the
traders to make a larger profi t (or loss) with a comparatively small
amount of capital.
Options trading will be of interest to those who wish to :
o Participate in the market without trading or holding a large quantity of
stock.
o Protect their portfolio by paying small premium amount.
Benefits of trading in Futures and Options :
o Able to transfer the risk to the person who is willing to accept them
o Incentive to make profi ts with minimal amount of risk capital
o Lower transaction costs
o Provides liquidity, enables price discovery in underlying market
o Derivatives market are lead economic indicators
9. Question 9. What Are The Benefits Of Trading In Index Futures Compared
To Any Other Security?
Answer :
An investor can trade the ‘entire stock market’ by buying index futures instead of
buying individual securities with the effi ciency of a mutual fund.
The advantages of trading in Index Futures are:
o The contracts are highly liquid.
o Index Futures provide higher leverage than any other stocks.
o It requires low initial capital requirement.
o It has lower risk than buying and holding stocks.
o It is just as easy to trade the short side as the long side.
o Only have to study one index instead of 100s of stocks

10. Question 10. How Do I Start Trading In The Derivatives Market At Nse?
Answer :
Futures/ Options contracts in both index as well as stocks can be bought and sold
through the trading members of NSE. Some of the trading members also provide
the internet facility to trade in the futures and options market. You are required to
open an account with one of the trading members and complete the related
formalities which include signing of member-constituent agreement, Know Your
Client (KYC) form and risk disclosure document. The trading member will allot to
you an unique client identifi cation number. To begin trading, you must deposit
 cash and/or other collaterals with your trading member as may be stipulated by
him
11. Question 11. What Is The Expiration Day?
Answer :
It is the last day on which the contracts expire. Futures and Options contracts
expire on the last Thursday of the expiry month. If the last Thursday is a trading
holiday, the contracts expire on the previous trading day. For E.g. The January
2008 contracts mature on January 31, 2008.

12. Question 12. What Is The Contract Cycle For Equity Based Products In Nse
?
Answer :
Futures and Options contracts have a maximum of 3-month trading cycle -the
near month (one), the next month (two) and the far month (three), except for the
Long dated Options contracts. New contracts are introduced on the trading day
following the expiry of the near month contracts. The new contracts are introduced
for a three month duration. This way, at any point in time, there will be 3 contracts
available for trading in the market (for each security) i.e., one near month, one mid
month and one far month duration respectively. For example on January 26,2008
there would be three month contracts i.e. Contracts expiring on January 31,2008,
February 28, 2008 and March 27, 2008. On expiration date i.e January 31,2008,
new contracts having maturity of April 24,2008 would be introduced for trading.

13. Question 13. What Is The Concept Of In The Money, At The Money And Out
Of The Money In Respect Of Options?
Answer :
In- the- money options (ITM): An in-the-money option is an option that would
lead to positive cash fl ow to the holder if it were exercised immediately. A Call
option is said to be in-the-money when the current price stands at a level higher
than the strike price. If the Spot price is much higher than the strike price, a Call is
said to be deep in-the-money option. In the case of a Put, the put is in-the-money
if the Spot price is below the strike price.
At-the-money-option (ATM):An at-the money option is an option that would lead
to zero cash fl ow if it were exercised immediately. An option on the index is said
to be “at-the-money” when the current price equals the strike price.
Out-of-the-money-option (OTM):An out-of- the-money Option is an option that
would lead to negative cash fl ow if it were exercised immediately. A Call option is
out-of-the-money when the current price stands at a level which is less than the
strike price. If the current price is much lower than the strike price the call is said
to be deep out-of-the money. In case of a Put, the Put is said to be out-of-money if
current price is above the strike price.
14. Question 14. Is There Any Margin Payable?
Answer :
Yes. Margins are computed and collected on-line, real time on a portfolio basis at
the client level. Members are required to collect the margin upfront from the client
& report the same to the Exchange.
 Question 15. How Are The Contracts Settled?
Answer :
All the Futures and Options contracts are settled in cash on a daily basis and at
the expiry or exercise of the respective contracts as the case may be.
Clients/Trading Members are not required to hold any stock of the underlying for
dealing in the Futures / Options market. All out of the money and at the money
option contracts of the near month maturity expire worthless on the expiration
date.

Option greeks
they’ll affect the price of every option you trade.

What is Delta?

Beginning option traders sometimes assume that when a stock moves $1, the price of
options based on that stock will move more than $1. That’s a little silly when you really
think about it. The option costs much less than the stock. Why should you be able to
reap even more benefit than if you owned the stock?

It’s important to have realistic expectations about the price behavior of the options you
trade. So the real question is, how much will the price of an option move if the stock
moves $1? That’s where “delta” comes in.

Delta is the amount an option price is expected to move based on a $1 change in

the underlying stock.

Calls have positive delta, between 0 and 1. That means if the stock price goes up and no
other pricing variables change, the price for the call will go up. Here’s an example. If a
call has a delta of .50 and the stock goes up $1, in theory, the price of the call will go up
about $.50. If the stock goes down $1, in theory, the price of the call will go down about
$.50.

Puts have a negative delta, between 0 and -1. That means if the stock goes up and no
other pricing variables change, the price of the option will go down. For example, if a put
has a delta of -.50 and the stock goes up $1, in theory, the price of the put will go down
$.50. If the stock goes down $1, in theory, the price of the put will go up $.50.

As a general rule, in-the-money options will move more than out-of-the-money

options, and short-term options will react more than longer-term options to the
same price change in the stock.

As expiration nears, the delta for in-the-money calls will approach 1, reflecting a one-to-
one reaction to price changes in the stock. Delta for out-of the-money calls will approach
0 and won’t react at all to price changes in the stock. That’s because if they are held until
expiration, calls will either be exercised and “become stock” or they will expire worthless
and become nothing at all.

As expiration approaches, the delta for in-the-money puts will approach -1 and delta for
out-of-the-money puts will approach 0. That’s because if puts are held until expiration,
the owner will either exercise the options and sell stock or the put will expire worthless.

So far we’ve given you the textbook definition of delta.

But here’s another useful way to think about delta: the probability an option will
wind up at least $.01 in-the-money at expiration.

Technically, this is not a valid definition because the actual math behind delta is not an
advanced probability calculation. However, delta is frequently used synonymously with
probability in the options world.

In casual conversation, it is customary to drop the decimal point in the delta figure, as in,
“My option has a 60 delta.” Or, “There is a 99 delta I am going to have a beer when I
finish writing this page.”

Usually, an at-the-money call option will have a delta of about .50, or “50 delta.” That’s
because there should be a 50/50 chance the option winds up in- or out-of-the-money at
expiration. Now let’s look at how delta begins to change as an option gets further in- or
out-of-the-money.
As an option gets further in-the-money, the probability it will be in-the-money at
expiration increases as well. So the option’s delta will increase. As an option gets
further out-of-the-money, the probability it will be in-the-money at expiration decreases.
So the option’s delta will decrease.

Imagine you own a call option on stock XYZ with a strike price of $50, and 60 days prior
to expiration the stock price is exactly $50. Since it’s an at-the-money option, the delta
should be about .50. For sake of example, let’s say the option is worth $2. So in theory,
if the stock goes up to $51, the option price should go up from $2 to $2.50.

What, then, if the stock continues to go up from $51 to $52? There is now a higher
probability that the option will end up in-the-money at expiration. So what will happen to
delta? If you said, “Delta will increase,” you’re absolutely correct.
If the stock price goes up from $51 to $52, the option price might go up from $2.50 to
$3.10. That’s a $.60 move for a $1 movement in the stock. So delta has increased from
.50 to .60 ($3.10 - $2.50 = $.60) as the stock got further in-the-money.

On the other hand, what if the stock drops from $50 to $49? The option price might go
down from $2 to $1.50, again reflecting the .50 delta of at-the-money options ($2 - $1.50
= $.50). But if the stock keeps going down to $48, the option might go down from $1.50
to $1.10. So delta in this case would have gone down to .40 ($1.50 - $1.10 = $.40). This
decrease in delta reflects the lower probability the option will end up in-the-money at
expiration.

Like stock price, time until expiration will affect the probability that options will finish in- or
out-of-the-money. That’s because as expiration approaches, the stock will have less
time to move above or below the strike price for your option.

Because probabilities are changing as expiration approaches, delta will react differently
to changes in the stock price. If calls are in-the-money just prior to expiration, the delta
will approach 1 and the option will move penny-for-penny with the stock. In-the-money
puts will approach -1 as expiration nears.

If options are out-of-the-money, they will approach 0 more rapidly than they would
further out in time and stop reacting altogether to movement in the stock.

Imagine stock XYZ is at $50, with your $50 strike call option only one day from
expiration. Again, the delta should be about .50, since there’s theoretically a 50/50
chance of the stock moving in either direction. But what will happen if the stock goes up
to $51?

Think about it. If there’s only one day until expiration and the option is one point in-the-
money, what’s the probability the option will still be at least $.01 in-the-money by
tomorrow? It’s pretty high, right?

Of course it is. So delta will increase accordingly, making a dramatic move from .50 to
about .90. Conversely, if stock XYZ drops from $50 to $49 just one day before the option
expires, the delta might change from .50 to .10, reflecting the much lower probability that
the option will finish in-the-money.

So as expiration approaches, changes in the stock value will cause more dramatic
changes in delta, due to increased or decreased probability of finishing in-the-money.
 Don’t forget: the “textbook definition” of delta has nothing to do
with the probability of options finishing in- or out-of-the-money. Again, delta is simply the
amount an option price will move based on a $1 change in the underlying stock.

But looking at delta as the probability an option will finish in-the-money is a pretty nifty
way to think about it.

Gamma is the rate that delta will change based on a $1 change in the stock price. So if
delta is the “speed” at which option prices change, you can think of gamma as the
“acceleration.” Options with the highest gamma are the most responsive to changes in
the price of the underlying stock.

As we’ve mentioned, delta is a dynamic number that changes as the stock price
changes. But delta doesn’t change at the same rate for every option based on a given
stock. Let’s take another look at our call option on stock XYZ, with a strike price of $50,
to see how gamma reflects the change in delta with respect to changes in stock price
and time until expiration (Figure 1).

Figure 1: Delta and Gamma for Stock XYZ Call with $50 strike price

Note how delta and gamma change as the stock price moves up or down from $50 and
the option moves in- or out-of-the-money. As you can see, the price of at-the-money
options will change more significantly than the price of in- or out-of-the-money options
with the same expiration. Also, the price of near-term at-the-money options will change
more significantly than the price of longer-term at-the-money options.

So what this talk about gamma boils down to is that the price of near-term at-the-
money options will exhibit the most explosive response to price changes in the
stock.

If you’re an option buyer, high gamma is good as long as

your forecast is correct. That’s because as your option moves in-the-money, delta will
approach 1 more rapidly. But if your forecast is wrong, it can come back to bite you by
rapidly lowering your delta.
If you’re an option seller and your forecast is incorrect, high gamma is the enemy.
That’s because it can cause your position to work against you at a more accelerated rate
if the option you’ve sold moves in-the-money. But if your forecast is correct, high gamma
is your friend since the value of the option you sold will lose value more rapidly.
Time decay, or theta, is enemy number one for the option buyer. On the other
hand, it’s usually the option seller’s best friend. Theta is the amount the price of calls
and puts will decrease (at least in theory) for a one-day change in the time to expiration.
Figure 2: Time decay of an at-the-money call option

This graph shows how an at-the-money option’s value will decay over the last three months until expiration. Notice how
time value melts away at an accelerated rate as expiration approaches.

This graph shows how an at-the-money option’s value will decay over the last three
months until expiration. Notice how time value melts away at an accelerated rate as
expiration approaches.

In the options market, the passage of time is similar to the effect of the hot summer sun
on a block of ice. Each moment that passes causes some of the option’s time value
to “melt away.” Furthermore, not only does the time value melt away, it does so at an
accelerated rate as expiration approaches.
Check out figure 2. As you can see, an at-the-money 90-day option with a premium of
$1.70 will lose $.30 of its value in one month. A 60-day option, on the other hand, might
lose $.40 of its value over the course of the following month. And the 30-day option will
lose the entire remaining $1 of time value by expiration.

At-the-money options will experience more significant dollar losses over time than in- or
out-of-the-money options with the same underlying stock and expiration date. That’s
because at-the-money options have the most time value built into the premium.
And the bigger the chunk of time value built into the price, the more there is to
lose.

Keep in mind that for out-of-the-money options, theta will be lower than it is for at-the-
money options. That’s because the dollar amount of time value is smaller. However, the
loss may be greater percentage-wise for out-of-the-money options because of the
smaller time value.

When reading the plays, watch for the net effects of theta in the section called “As time
goes by.”

Figure 3: Vega for the at-the-money options based on

Stock XYZ

Obviously, as we go further out in time, there will be more time value built into the option contract. Since implied
volatility only affects time value, longer-term options will have a higher vega than shorter-term options.
When reading the plays, watch for the effect of vega in the section called “Implied volatility.”

You can think of vega as the Greek who’s a little shaky and over-caffeinated. Vega is
the amount call and put prices will change, in theory, for a corresponding one-
point change in implied volatility. Vega does not have any effect on the intrinsic value
of options; it only affects the “time value” of an option’s price.

Typically, as implied volatility increases, the value of options will increase. That’s
because an increase in implied volatility suggests an increased range of potential
movement for the stock.

Let’s examine a 30-day option on stock XYZ with a $50 strike price and the stock exactly
at $50. Vega for this option might be .03. In other words, the value of the option might go
up $.03 if implied volatility increases one point, and the value of the option might go
down $.03 if implied volatility decreases one point.

Now, if you look at a 365-day at-the-money XYZ option, vega might be as high as .20.
So the value of the option might change $.20 when implied volatility changes by a point
(see figure 3).

If you’re a more advanced option trader, you might have noticed we’re missing a Greek
— rho. That’s the amount an option value will change in theory based on a one
percentage-point change in interest rates.

Rho just stepped out for a gyro, since we don’t talk about him that much in this site.
Those of you who really get serious about options will eventually get to know this
character better.

For now, just keep in mind that if you are trading shorter-term options, changing interest
rates shouldn’t affect the value of your options too much. But if you are trading longer-
term options such as LEAPS, rho can have a much more significant effect due to greater
“cost to carry.”

Assumptions of black scholes merton model

What Is the Black Scholes Model?

The Black Scholes model, also known as the Black-Scholes-Merton (BSM)
model, is a mathematical model for pricing an options contract. In particular,
the model estimates the variation over time of financial instruments such as
stocks, and using the implied volatility of the underlying asset derives the price
of a call option.

The model assumes the price of heavily traded assets follows a geometric Brownian motion
with constant drift and volatility. When applied to a stock option, the model incorporates the
constant price variation of the stock, the time value of money, the option's strike price, and
the time to the option's expiry.

Also called Black-Scholes-Merton, it was the first widely used model for option pricing. It's
used to calculate the theoretical value of options using current stock prices, expected
dividends, the option's strike price, expected interest rates, time to expiration and expected
volatility.

The formula, developed by three economists—Fischer Black, Myron Scholes and Robert
Merton—is perhaps the world's most well-known options pricing model. It was introduced in
their 1973 paper, "The Pricing of Options and Corporate Liabilities," published in the Journal
of Political Economy. Black passed away two years before Scholes and Merton were awarded
the 1997 Nobel Prize in Economics for their work in finding a new method to determine the
value of derivatives (the Nobel Prize is not given posthumously; however, the Nobel
committee acknowledged Black's role in the Black-Scholes model).

The Black-Scholes model makes certain assumptions:

• The option is European and can only be exercised at expiration.

• No dividends are paid out during the life of the option.
• Markets are efficient (i.e., market movements cannot be predicted).
• There are no transaction costs in buying the option.
• The risk-free rate and volatility of the underlying are known and constant.
• The returns on the underlying are normally distributed.

While the original Black-Scholes model didn't consider the effects of dividends paid during
the life of the option, the model is frequently adapted to account for dividends by determining
the ex-dividend date value of the underlying stock.

The Black Scholes Formula

The mathematics involved in the formula are complicated and can be intimidating.
Fortunately, you don't need to know or even understand the math to use Black-Scholes
modeling in your own strategies. Options traders have access to a variety of online options
calculators, and many of today's trading platforms boast robust options analysis tools,
including indicators and spreadsheets that perform the calculations and output the options
pricing values.

The Black Scholes call option formula is calculated by multiplying the stock price by the
cumulative standard normal probability distribution function. Thereafter, the net present
value (NPV) of the strike price multiplied by the cumulative standard normal distribution is
subtracted from the resulting value of the previous calculation.

In mathematical notation:
\begin{aligned} &C = S_t N(d _1) - K e ^{-rt} N(d _2)\\ &\textbf{where:}\\
&d_1 = \frac{ln\frac{S_t}{K} + (r+ \frac{\sigma ^{2} _v}{2}) \ t}{\sigma_s \
\sqrt{t}}\\ &\text{and}\\ &d_2 = d _1 - \sigma_s \ \sqrt{t}\\ &\textbf{where:}\\
&C = \text{Call option price}\\ &S = \text{Current stock (or other underlying)
price}\\ &K = \text{Strike price}\\ &r = \text{Risk-free interest rate}\\ &t =
\text{Time to maturity}\\ &N = \text{A normal distribution}\\ \end{aligned}
C=StN(d1)−Ke−rtN(d2)where:d1=σs tlnKSt+(r+2σv2) tandd2=d1−σs t
where:C=Call option priceS=Current stock (or other underlying) priceK
=Strike pricer=Risk-
free interest ratet=Time to maturityN=A normal distribution
Black-Scholes Model
What Does the Black Scholes Model Tell You?
The Black Scholes model is one of the most important concepts in modern
financial theory. It was developed in 1973 by Fischer Black, Robert Merton,
and Myron Scholes and is still widely used today. It is regarded as one of the
best ways of determining fair prices of options. The Black Scholes model
requires five input variables: the strike price of an option, the current stock
price, the time to expiration, the risk-free rate, and the volatility.

The model assumes stock prices follow a lognormal distribution because

asset prices cannot be negative (they are bounded by zero). This is also
known as a Gaussian distribution. Often, asset prices are observed to have
significant right skewness and some degree of kurtosis (fat tails). This means
high-risk downward moves often happen more often in the market than a
normal distribution predicts.

The assumption of lognormal underlying asset prices should thus show that
implied volatilities are similar for each strike price according to the Black-
Scholes model. However, since the market crash of 1987, implied volatilities
for at the money options have been lower than those further out of the
money or far in the money. The reason for this phenomena is the market is
pricing in a greater likelihood of a high volatility move to the downside in the
markets.

This has led to the presence of the volatility skew. When the implied volatilities
for options with the same expiration date are mapped out on a graph, a smile
or skew shape can be seen. Thus, the Black-Scholes model is not efficient for
calculating implied volatility.

Limitations of the Black Scholes Model

As stated previously, the Black Scholes model is only used to price European
options and does not take into account that U.S. options could be exercised
before the expiration date. Moreover, the model assumes dividends and risk-
free rates are constant, but this may not be true in reality. The model also
assumes volatility remains constant over the option's life, which is not the case
because volatility fluctuates with the level of supply and demand.

Moreover, the model assumes that there are no transaction costs or taxes;
that the risk-free interest rate is constant for all maturities; that short selling of
securities with use of proceeds is permitted; and that there are no risk-less
arbitrage opportunities. These assumptions can lead to prices that deviate
from the real world where these factors are present.