Option pricing using monte carlo simulation

Abstract

Special features that options include are the main reason of their growing amounts trading in the financial markets. Options can be used in many imaginative ways to create various attractive investment opportunities. Empirical researches all over the world illustrated that options incorporate an insurance element not available in any other security and because of that they can be used by investors to create return distributions unobtainable with the strategy of allocating funds between fixed income securities and stock portfolios. But investor must understand that one of the main aspects of profitable trading in derivative securities is their proper evaluation and pricing. As the exact valuation of options is quite difficult, the article deals with the theoretical and practical aspects of pricing of options. The purpose of the research is to adopt Monte Carlo simulation method to predict prices of plain vanilla options and to compare them to real option prices and option prices calculated using analytical Black-Scholes formula.