medium · Quantitative Finance stochastic
The BSM PDE derivation assumes the 'Law of One Price'. How does this principle apply to the hedged portfolio Π?
- It requires that the call price plus the put price on the same strike always equal exactly the stock price S.
- Since the portfolio Π is riskless, its price must be equal to the price of a risk-free bond with the same cash flow.
- It implies that the implied volatility of all options traded on that same underlying stock must be exactly equal.
- It states that the current stock price S must always equal its expected future value discounted at the real-world drift μ.
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