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In a discrete-time binomial market with $B_t=(1+r{)}^t$ and one-step stock factors $1\pm \epsilon$, use the risk-neutral probability $p=(1+r/\epsilon )/2$, where $0\le r<\epsilon <1$. For the exercise payoff $S_t^2$, the discounted one-step reward multiplier has meanThe Snell envelope of a multiplicative process gives the value $V_t=S_t^2{\lambda }^{T-t}$. Continuation strictly exceeds exercise before maturity, so the optimal exercise time is $T$. The replicating portfolio in a binomial market holds $2S_t{\lambda }^{T-t-1}$ shares on the next step, found by subtracting the two next-state values and dividing by the stock-price difference. At time zero the price is $S_0^2{\lambda }^T$.

This additive price model has constant absolute volatility and can take negative stock values. With constant cash interest rate $r$, its market price of risk is $(\mu -r{S}_t)/\sigma$. Under an equivalent risk-neutral measure, its drift becomes $r{S}_t$, so its conditional law is Gaussian with mean $e^{r(T-t)}{S}_t$ and variance ${\sigma }^2(e^{2r(T-t)}-1)/(2r)$. It is distinct from a multiplicative Black–Scholes diffusion.

An option whose payoff depends on an average of the underlying stock prices over time. The displayed arithmetic-average call differs from a geometric-average call, which uses the geometric mean. A convex payoff and a nondecreasing positive numéraire give an upper bound by the average costs of same-strike European call options at the averaging dates.

When the underlying stock pays dividends at rate $\theta S_t$, its gain is $d{S}_t+\theta S_{t}dt$. Under the risk-neutral measure its ex-dividend drift is $(\rho -\theta )S_t$. A sufficiently smooth terminal-claim value obeys $p_t+(\rho -\theta )x{p}_x+{\sigma }^2{x}^2{p}_{xx}/2-\rho p=0$. These are dividends on the stock, not a source term paid by the claim itself.

In the cash-numéraire market $d{S}_t=a(S_t)d{W}_t$, let a smooth call value solve $V_t+\frac{1}{2}{a}^2{V}_{SS}=0$. Its delta hedge is $U=V_S$. Differentiating the pricing equation giveswith the terminal value at the strike understood up to the null probability of the diffusion hitting that exact terminal value. By Itô formula, $dU(t,S_t)=-a{a}^{\prime }{U}_{S}dt+a{U}_{S}d{W}_t$, while $dV(t,S_t)=U(t,S_t)d{S}_t$. Thus holding $U(t,S_t)$ shares and cash $V-SU$ replicates the terminal call. The drift in the option delta equation comes from differentiating the spatially varying diffusion coefficient, not from a drift in the original stock.

A financial option granting the right to buy its underlying financial asset at a specified strike price $K$. Its exercise payoff on one stock share is the positive part $(S-K{)}^{+}$. A European call option permits exercise at expiry, while an American call option also permits earlier exercise. A forward-start call option determines the strike at a future fixing date.

In a zero-interest one-period market with a continuous terminal stock law under a pricing measure, $C(K)={\mathbb{E}}_Q(S-K{)}^{+}$ implies $-C^{\prime }(K)=Q(S>K)$ and $C^{\prime \prime }(K)=f_Q(K)$. Thus a full differentiable call curve determines its pricing density. A finite collection of strikes generally does not. With a deterministic nonunit discount factor, divide the call curve by that factor before recovering the probability density.

Let $\nu =\sigma \sqrt{(1-e^{-2r\tau })/(2r)}$ and $d=(s-K{e}^{-r\tau })/\nu$, where $\tau =T-t$. The displayed discounted Gaussian positive-part expectation prices a call in the arithmetic stock model with constant volatility. Its delta is $\Phi (d)$. The stock holding $C_s$ and bank-account holding $(C-s{C}_s)/B$ replicate the payoff with nonnegative wealth. A nonnegative discounted-wealth supermartingale bound proves this is the least replication capital.

A barrier claim paying a fixed cash amount at the first time the stock reaches a higher level, provided this happens before expiry. In the Black-Scholes model, take $a=\log (c/S_0)/\sigma$ and $b=({\sigma }^2/2-\rho )/\sigma$. Its unit-cash price is ${\mathbb{E}}_Q[e^{-\rho T_{a,b}}{1}_{\{T_{a,b}\le T\}}]$, given by truncated discounted Brownian first passage. The effective square root $\sqrt{b^2+2\rho }=|\rho +{\sigma }^2/2|/\sigma$ is real for every real interest rate.

In the Black-Scholes model, suppose a stock pays continuous dividend yield $q$, a claim pays cash flow $f(t)S_{t}dt$, and its terminal financial payoff is $c{S}_T$. If the discounted cash-flow integral is finite, its risk-neutral pricing value is the displayed expression. To derive it, substitute $V=S\varphi (t)$ into the Black-Scholes equation with claim dividends, including stock drift $(r-q)S$. This gives ${\varphi }^{\prime }-q\varphi =-f$, $\varphi (T)=c$, which an integrating factor solves. The interest rate cancels because all payments are proportional to the same stock.

For a log-mean-reverting price, set $a=e^{-\alpha (T-t)}$. The Ornstein-Uhlenbeck transition distribution gives conditional log-mean $a\log S_t+(1-a)\tilde{\mu }$ and log-variance ${\sigma }^2(1-a^2)/(2\alpha )$. The moment-generating function of a normal distribution therefore gives the displayed formula for $F(t,T)=\mathbb{E}[S_T\mid {\mathcal{F}}_t]$. It is a martingale in $t$ for fixed $T$, by the tower property of conditional expectation, and the Itô formula yieldsThis uses the same probability measure as the specified conditional expectation. It describes futures pricing only when that measure is an appropriate pricing measure, with the required cash-flow conventions. For a non-dividend-paying traded stock and constant interest rate, the forward contract delivery price follows the usual carry relation instead.

A constant-proportion portfolio holds a fixed fraction $\gamma$ of its portfolio wealth in the stock. In the Black-Scholes model with bank rate $\rho$, initial wealth $V_0$, and no consumption, its value isThe stock holding is $\gamma V_t/S_t$ and the remaining value $(1-\gamma )V_t$ is invested in the bank account. The Itô formula verifies $d{V}_t/V_t=[\rho +\gamma (\mu -\rho )]dt+\gamma \sigma d{W}_t$ when the physical stock drift is $\mu$.

A proportional continuous dividend payment at rate $\delta$ per unit time relative to the ex-dividend stock price. The total gain of one share is $d{S}_t+\delta S_{t}dt$. Under a risk-neutral measure with short rate $r$, a geometric stock diffusion therefore has ex-dividend drift $(r-\delta )S_t$. A fixed cash dividend at a specified date is a different convention and generally requires an ex-dividend price jump.

In the Black-Scholes model the terminal stock price conditional on current price $x$ is $xM$ for a positive lognormal multiplier $M$. Differentiation under the risk-neutral pricing expectation gives the displayed option gamma. Its sign follows that of $f^{\prime \prime }$, so convexity and concavity of the terminal payoff are preserved. An analogous first-derivative identity preserves monotonicity. With appropriate growth conditions, Gaussian integration by parts also gives $V_{\sigma }=\sigma (T-t)x^2{V}_{xx}$, fixing the sign of option vega for these payoff classes.

A stock model whose price can be killed or reduced at a default time. The zero-recovery default model combines continuous price dynamics before default with a jump to zero.

For strike $c>b$, write $C(s,c,\tau )$ for the ordinary European call option value. Before activation the down-and-in claim is $I(s,\tau )=(b/s{)}^{\alpha }C(b^2/s,c,\tau )$, where $\alpha =2\rho /{\sigma }^2-1$. Consequently its left-limit option delta at the barrier is $-\alpha C(b,c,\tau )/b-C_s(b,c,\tau )$, whereas after activation it is $C_s(b,c,\tau )$. Their difference is strictly positive for $\tau >0$: differentiating the killed normal transition density at its boundary gives the integral of a strictly positive function against the positive call payoff. The value is continuous, so changing the bank holding finances the stock rebalance.

When a productive stock pays $d_t$ before trading at ex-dividend price $S_t$, an investor entering with ${\theta }_t$ shares receives $d_t{\theta }_t$ and sells or buys shares to leave with ${\theta }_{t+1}$. The displayed budget constraint accounts for the available consumption and the cost of the new holding. Here ${\theta }_t$ is known before date $t$, while $C_t$ and ${\theta }_{t+1}$ may depend on the information revealed at that date.

At each node a positive stock price moves to $u{S}_t$ or $d{S}_t$, with $0<d<u$, while a bank account grows by a fixed gross factor $R>0$. Assume both successors have positive physical probability, no dividends, a frictionless market with no trading costs, divisible holdings, unrestricted short selling, and borrowing and lending at the same fixed $R$. A self-financing portfolio receives no outside cash after its initial funding; subsequent rebalancing uses its own proceeds.

This binomial market excludes arbitrage exactly when $d<R<u$. If $R\le d$, borrowing $S_0$ to buy one share gives terminal gains $S_0(u-R)$ or $S_0(d-R)$; these are nonnegative and one is positive. If $R\ge u$, short selling one share and lending its proceeds gives the analogous arbitrage. Strict inequalities allow a positive risk-neutral probability for each state. The two traded payoffs also span both successor states, giving market completeness relative to the information generated by this tree.

A positive state-price density prices a productive stock through a conditional dividend sum plus a future deflated-price term. The displayed condition removes that terminal term, yielding transversality and fundamental dividend prices. An individual consumption budget instead has terminal term $\mathbb{E}[{\zeta }_N{S}_N{\theta }_{N+1}]$, so its vanishing must be imposed or proved for the particular holdings as well.

Here $\Delta =\sqrt{(r-\delta -{\sigma }^2/2{)}^2+2r{\sigma }^2}$. Implicit differentiation of the negative-root equation gives $d{\beta }_{-}/d\delta =-{\beta }_{-}/\Delta >0$. Differentiating $S^{\ast }=X{\beta }_{-}/({\beta }_{-}-1)$ gives the displayed negative derivative. A higher proportional dividend yield lowers risk-neutral stock growth and makes waiting for lower stock prices more attractive to the put holder.