The Stop-Loss Start-Gain Paradox and Option Valuation: A New Decomposition into Intrinsic and Time Value

Peter Carr and Robert Jarrow ()

The Review of Financial Studies, 1990, vol. 3, issue 3, 469-92

Abstract: The downside risk in a leveraged stock position can be eliminated by using stop-loss orders. The upside potential of such a position can be captured using contingent buy orders. The terminal payoff to this stop-loss start-gain strategy is identical to that of a call option, but the strategy costs less initially. This article resolves this paradox by showing that the strategy is not self-financing for continuous stock- price processes of unbounded variation. The resolution of the paradox leads to a new decomposition of an option's price into its intrinsic and time value. When stock price follows geometric Brownian motion, this decomposition is proven to be mathematically equivalent to the Black-Scholes (1973) formula. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Date: 1990
References: Add references at CitEc
Citations: View citations in EconPapers (24)

Downloads: (external link)
http://www.jstor.org/fcgi-bin/jstor/listjournal.fcg/08939454 full text (application/pdf)
Access to full text is restricted to JSTOR subscribers. See http://www.jstor.org for details.

Related works:
Chapter: The Stop-Loss Start-Gain Paradox and Option Valuation: A new Decomposition into Intrinsic and Time Value (2008)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:rfinst:v:3:y:1990:i:3:p:469-92

Ordering information: This journal article can be ordered from
https://academic.oup.com/journals

Access Statistics for this article

The Review of Financial Studies is currently edited by Itay Goldstein

More articles in The Review of Financial Studies from Society for Financial Studies Oxford University Press, Journals Department, 2001 Evans Road, Cary, NC 27513 USA.. Contact information at EDIRC.
Bibliographic data for series maintained by Oxford University Press ().