Tuesday, February 19, 2008

Buyer's Option Price in the Prescence of Secondary Markets

Hi All,

I am currently studying derivatives and trying to improve my understanding on them. I have being thinking about the value of an option. This has two sides of it as I see it: 1) the writer's perspective and 2) buyers perspective.

Option pricing, what ever pricing formular used, takes into account the probability adjusted cash out flow of writing an option on expiration of exercising.

Since the option can be sold in the secondary market from the buyers perspective he has the chance of altering the expected cash inflow buy selling it. I have a feeling that this can be worked out by double integrating the option pricing formula used across the distribution of price over the life of the options. This expected value may be different from the option price.
Any comments on this? If you can direct me to online literature on similar thoughts I would be very happy.

Suminda Sirinath Salpitikorala Dharmasena

P.S. due to secondary markets the writer can also close his position early by buying back the option - S.S.S.D.

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