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Guide
Derivatives pricing
01Forwards, calls and puts02Combining positions03Arbitrage and the forward price04Put–call parity05The one-step binomial model06Risk-neutral probabilities07Multi-step trees and backward induction08American options and early exercise09Delta and hedging10Geometric Brownian motion11The Black–Scholes formula12The Greeks: gamma, vega, theta and rho13Implied volatility and the volatility smile14Stochastic volatility and the Heston model15Static replication: Breeden–Litzenberger and Carr–Madan16Exotic options: barriers, Asians and digitals
Portfolio & risk
01Returns and volatility02Diversification and correlation03The efficient frontier and the capital market line04Risk aversion and the optimal complete portfolio05CAPM, beta and the security market line06Performance measures: Sharpe, Treynor, Jensen and information ratio07Factor models and systematic risk08Value at Risk and expected shortfall
Fixed income
01Bond prices and yields02Duration and convexity03Immunization and duration matching04Spot rates, forward rates and the yield curve05Bond futures and the cheapest-to-deliver06Interest rate swaps07Callable bonds and negative convexity08Credit risk: default probabilities and credit spreads
Corporate finance
01Interest, compounding and discounting02Annuities, perpetuities and loan amortization03Net present value and internal rate of return04The weighted average cost of capital05Capital structure and the Modigliani–Miller theorems06Discounted cash flow valuation07Relative valuation with multiples08Real options: the value of flexibility
Stochastic models
01Random walks and Brownian motion02Probability spaces, σ-algebras and random variables03Filtrations, adapted processes and stopping times04Conditional expectation and martingales05Properties of Brownian motion06The reflection principle and first passage times07The Brownian bridge08The Itô integral09Itô's lemma10Kolmogorov equations and the Feynman–Kac formula11Change of measure and Girsanov's theorem12Monte Carlo option pricing13Simulating SDEs: the Euler–Maruyama scheme14Mean reversion: Ornstein–Uhlenbeck and Vasicek15Jumps and the Merton jump-diffusion model
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Guide

Lessons meant to be read in order. Each one only uses what came before it.

Derivatives pricing

From payoffs, through arbitrage-free pricing and the binomial tree, to the Black–Scholes formula.

Start
0 of 16 read
  1. 01Forwards, calls and putsWhat a derivative is; payoffs of forwards, calls and puts at maturity; long and short positions.
  2. 02Combining positionsPayoffs add up: spreads, straddles, strangles, butterflies and the synthetic forward.
  3. 03Arbitrage and the forward priceThe law of one price, the cash-and-carry trade and the fair forward price.
  4. 04Put–call parityTwo portfolios with the same payoff give a model-free link between call and put prices.
  5. 05The one-step binomial modelThe stock moves up or down; replicating a call with stock and a bond.
  6. 06Risk-neutral probabilitiesThe replication price as a discounted expectation with weights q; the roles of P and Q.
  7. 07Multi-step trees and backward inductionRecombining trees, the CRR parametrisation, pricing node by node and convergence to Black–Scholes.
  8. 08American options and early exerciseEarly exercise in a tree, why calls without dividends are never exercised early, the early-exercise premium of a put and the exercise boundary.
  9. 09Delta and hedgingDelta as a sensitivity and as a hedge ratio; gamma and the error from discrete rebalancing.
  10. 10Geometric Brownian motionThe standard model for stock prices: the log-normal distribution, its mean and its median.
  11. 11The Black–Scholes formulaHow the formula is obtained, what d₁ and d₂ mean, and what the model leaves out.
  12. 12The Greeks: gamma, vega, theta and rhoHow an option's value responds to the stock, volatility, time and rates; gamma and theta as two sides of hedging.
  13. 13Implied volatility and the volatility smileInverting Black–Scholes for σ, vega, and what the smile and the term structure say about the model.
  14. 14Stochastic volatility and the Heston modelThe Heston variance process, mean reversion, vol-of-vol, the Feller condition, and how correlation and vol-of-vol shape the smile.
  15. 15Static replication: Breeden–Litzenberger and Carr–MadanThe risk-neutral density from call prices, and building any payoff from bonds, forwards and options.
  16. 16Exotic options: barriers, Asians and digitalsPath-dependent payoffs, the effect of a knock-out barrier and of averaging, and why Monte Carlo is the natural tool.

Check yourself

Questions from the lessons of this series. Open a lesson's group whenever you want to test yourself.

American options and early exercise2 questionsRe-read the lesson →
Check yourself

At a node of the tree S=80S = 80S=80, the strike of an American put is K=100K = 100K=100, and the continuation value is 18.518.518.5. What is the node worth?

Check yourself

Why is an American call on a stock without dividends never exercised early?

Stochastic volatility and the Heston model2 questionsRe-read the lesson →
Check yourself

In the Heston model the variance mean-reverts with speed κ=4\kappa = 4κ=4. What is the half-life of a variance shock, in years?

Check yourself

With ρ=−0.7\rho = -0.7ρ=−0.7, which options have a higher implied volatility than the at-the-money ones?

About this tool

Narrative guides that connect the interactive tools into a story: financial instruments and their payoffs, the no-arbitrage principle, risk-neutral pricing, delta hedging and the road to the Black–Scholes formula. Each guide links to the labs where you can try the ideas yourself.

Frequently asked questions

In what order should I read the guides?

Start with instruments and no-arbitrage, then risk-neutral pricing and delta hedging; together they lead to the Black–Scholes formula.

Who are the guides for?

Students of financial and insurance mathematics and anyone who wants intuition behind derivatives pricing, not just the formulas.