Why Should We Buy Options? A Graphical Presentation
16 Pages Posted: 23 May 2009 Last revised: 23 Jan 2011
Date Written: September 21, 2005
Abstract
The investor's utility function and anticipations will make her choose a specific payoff. The objective of this paper is to introduce a graphical presentation of the anticipations of the investor. Our objective is to make this presentation as simple as possible, so that a non-quantitative skilled economic agent can interpret it. In the context of more and more complex financial products, we believe that understanding anticipations is a key issue. First, we provide the theoretical foundations for this graphical presentation. The case for the logarithmic utility is studied. Then, a presentation of the subjective density functions is given for option payoffs with one or two observations (Call, Put, Call Spread, Put Spread, Asian Call). In order to extend our approach to more complex payoffs (path-dependent with more than two observations), we use the simplified approach of Cox, Ross and Rubinstein (1979). We propose an innovative graphical presentation that is based on a colour scale depending on the level of the investor's subjective probability associated to a node of the binomial tree.
Keywords: options, call, put, call spread, put spread, asian call, path-dependent, anticipations
JEL Classification: C1, C6
Suggested Citation: Suggested Citation