Pricing Derivatives
A derivative is an instrument that allows for buying and selling of the same asset on two markets – the spot market and the derivatives market. Mathematical finance assumes that any imbalance between the two markets will be arbitraged away. Thus, in a correctly priced derivative contract, the derivative price, the strike price (or reference rate), and the spot price will be related such that arbitrage is not possible.
- see: Fundamental theorem of arbitrage-free pricing
Read more about this topic: Rational Pricing