Here's my take on the "double" bit. That paragraph is trying to summarize
what the authors are doing in the chapter on option pricing. The general
method that they follow is to determine the [unknown] value of a given
option by constructing a combination of transactions that would have the
same outcome as holding the option. In the chapter, this involved
buying/selling shares of stock and borrowing/lending money at interest, so
that the value of this reference investment -- or "double" -- would mirror
the value of the option at the maturity date.
Since the "double" has the same return as the option, its current value must
be equal to that of the option. Otherwise, smart investors would jump on
one or the other for the arbitrage opportunity. The idea is find a current
value for the option by finding the value of an equivalent investment that
has the same returns. You can think of them as "doubles," "duals,"
"reference investments" or "benchmarks" -- whatever gets you through the
exam.
That's about all there is to it. Since this stuff is what helped me earn my
"5" in May, I am going to be sure that I have a lot of practice in 1)
evaluating options and 2) setting up hedges using combinations of simple
options.
Hope this puts it in perspective for you,
Chuck Thayer
-----Original Message-----
From: Rich Davey <RDAVO@allstate.com>
To: studygroup5b@lists.casact.org <studygroup5b@lists.casact.org>
Date: Wednesday, July 22, 1998 10:22 AM
Subject: Chapter 21
>Can someone please explain the 3rd paragraph on p.609 that starts
>"Think of each...". What is the "double" they refer to? This entire
>paragraph makes no sense to me.
>
>Rich Davey
>