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Complications in Valuing Options

 

  • Standard approach for valuing any asset:
    • Figure out expected cash flows and
    • Discount them at risk adjusted cost of capital reflecting the opportunity cost of capital.
  • Complications that arise in valuing Options
    • Impossible to quantify risks associated with the Option cash flows
    • Risks associated with the Option change every-time there is change in the price of the underlying





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