The Intuition Behind Option Valuation: A Teaching Note

Abstract

Option valuation is one of the most difficult topics to teach in the basic finance course. It is intimidating to many students as being too abstract and involving too much mathematics. The purpose of this paper is to introduce the essential ideas behind option valuation using an intuitive and visual approach.

We focus on building the student's intuition about uncertainty in stock prices and its impact on option value through simple examples and simulation. Nothing more than basic knowledge of probability distributions and present value is required to understand our approach.