Abstract
Option is derivative instrument that have investment benefit and provide return for the writer and the holder. Option price determination is affected by risk factor. However in Black-Scholes model option price is determined without arbitrage risk affection so it is impossible to take return. In this study, option price formula is constructed to be more represent the condition of financial market using incomplete market concept where financial asset, that is traded, is affected by arbitrage risk so it is possible for market participants to take return. European call option is defined by Esscher Transform method and option price formula is determined by changing its form to linear approximation. The result from this study is option price formula with linear approximation has some privileges. That is easy to be applied in computation process, more representatives in getting risk indication in the financial market and can predict option price more accurately. Linear approximation formula is applied in the program that can be used by option writer or holder and is equipped with export data feature that can be possible for further research development.
Highlights
Pradhitya et al (2012) states that: “Option is defined as a contract between two parties which gives the publisher the right but not the obligation to the holder of an optionBlack-Scholes model is not realistic and its validity is questionable
Option price formula is constructed to be more represent the condition of financial market using incomplete market concept where financial asset, that is traded, is affected by arbitrage risk so it is possible for market participants to take return
Formula of European call option price with linear approximation is an extension of Black-Scholes model where there is added value due to the skewness which showed the yield of the underlying asset is not normally spread
Summary
Pradhitya et al (2012) states that: “Option is defined as a contract between two parties (issuer and the holder of the option) which gives the publisher the right but not the obligation to the holder of an option. Black-Scholes model is not realistic and its validity is questionable This model assumes the absence of risk factors in arbitrage (Floroiu and Pelsser, 2012). Option is a hedging instrument in investing This instrument can be used in trading strategies, for example, to avoid the collapse of stock prices, shareholders may issue a call option so that the owner of the option can exercise his right to buy shares at the price stated in the option (Soesanto and Kaudin, 2008). R language will be used to calculate the statistical formula used by the European call option pricing model This system is expected to help stock investors who want to hedge with options traded and perform calculations efficiently
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