Options & Derivatives

Risk-Neutral Pricing

Valuing a derivative as the discounted expected payoff under a probability measure where all assets drift at the risk-free rate.

Risk-neutral probabilities are not beliefs. They are pricing weights implied by no-arbitrage, and confusing the two is the most common misunderstanding here.

The binomial model shows why: replicate the option with stock and cash, and the price falls out without the real probability of an up move ever appearing. Two traders who disagree violently about direction must still agree on the option price.

The formal statement: discounted asset prices are martingales under the risk-neutral measure.

Full guide

Black–Scholes and Risk-Neutral Pricing, Intuitively

Why an option has a single fair price at all - no-arbitrage, replication, and the risk-neutral trick - without the differential equation.

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Knowing the definition is not the same as spotting where it applies under time pressure. Work the question bank free.

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