## CHAPTER 13: VALUATION EXAMPLES AND TECHNIQUES

**13.1
Overview
**

T |

his chapter pulls together the various concepts you have
learned, and shows you how to apply them to actual option markets.
We look at three applications: __Stock
Options__ (topic 13.2), __Currency Forwards and
Futures__ (topic 13.3), and __Currency Options__
(topic 13.4).

One complication we will immediately encounter is that most
of the options that are traded are American options, not European options.
Yet most of the theory you have learned deals with European options.

Unfortunately, there are no pricing formulas for American
options. Instead, we use the same
methodology, but use a numerical procedure to obtain the option value.

Several methods are commonly used to obtain numerical
estimates of American option values. Three
examples are the __Finite Difference Method____
__(see topic 13.5), the
Barone-Adesi and Whaley (1987) __Quadratic
Approximation____ __(see
topic 13.6) and the __Binomial Method____
__(see topic 13.7). The first
solves the partial differential equation numerically.
The second method identifies a "stock cutoff" value for
exercising the option, and the third uses the binomial option pricing model.
Online, the **Option Calculator**
subject of Option Tutor, lets you choose which method you want to use to value
options.

A second complication comes from dividends, especially when
valuing stock options. It is
necessary to adjust the model to account for both discrete and continuous
dividends.