Zero-Strike Calls, Replication, and Model Assumptions
Summary
At expiration, a call with a zero strike pays the stock price when the stock price is nonnegative. The discussion asks whether this means the option should be worth the stock itself before expiration, and whether shareholder rights or counterparty risk create a price difference. One answer applies replication and the law of one price: if the stock’s payoff can be replicated by the call under the model’s assumptions, their values must match to avoid arbitrage.
That conclusion depends on the model and contract details. The replies distinguish models that keep stock prices nonnegative from models that allow negative values, where the zero-strike call can be worth more than spot. They also identify interest rates and dividends as important assumptions in the comparison. Voting rights, credit exposure, and the timing of dividends can affect real-world equivalence, though the discussion does not provide a general adjustment formula. The central lesson is to state the model’s price process and cash-flow assumptions before applying the replication argument.
Key ideas
- A zero-strike call pays the stock price at expiry when the stock cannot be negative.
- Under assumptions that make the call replicate the stock, no-arbitrage pricing equates their values.
- The relationship can differ in models that permit negative stock prices.
- Interest rates and dividends affect whether the option and stock have equivalent cash flows.
- Shareholder rights and counterparty exposure complicate real-world comparisons.
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Full text
# Why is the price of a call option with $K=0$ equal to the price of the stock $S_0$?
# Why is the price of a call option with $K=0$ equal to the price of the stock $S_0$?
In a case of a call option with strike $K=0$, then payoff at expiration time $T$ is equal to:
$$(S_T-0,0)^{+}=S_T$$
In reality the price of the option on the date of maturity is never equal to the stock price itself regardless of the strike price.
Why?
More details following comments:
Having the price of the call option equal to the stock price itself provided that the strike is zero implies that holding the call is equivalent to, i.e. generates the same value as, holding the stock.
However, holding the stock has something that holding the call does not offer, e.g. the right to vote and claim on a share of firm’s property.
Hence, holding the call option is not equivalent to holding the stock. Therefore, the price of the call will always be at least a little lower than the stock price itself.
## Answer by SRKX (score 6)
https://quant.stackexchange.com/a/16185
Buying a call at time $t=0$ with strike $K=0$ on a stock whose value is $S_0$ will produce the following cash flows ensure a cash flow at time $t=T$ of $S_T$, because as you mentioned $(S_T - 0, 0 )^{+}=S_T$ because $S_t \geq 0 ~ \forall t$ by definition.
This cash flow is replicable by buying the stock for $S_0$ at $t=0$.
By the law of one price, if there is no arbitrage then the price of the call has to be equal to the price of the replicating portfolio, which yields $c_t = S_t$ indeed.
What you're referring to about voting vote and credit risk is kind of different.
The credit risk part can be adjusted by some kind of CVA, but frankly as a share holder you will come after all debt holders and you probably don't have much to recover in case of bankruptcy.
The voting right part is actually very different. I don't really see why this would add value very much to the price of the stock, but if it was you could "model" it as some kind of dividend yield and you'll miss the opportunity of cashing in these dividends during the call's life. This would make the price of the call indeed lower than $S_0$.
## Answer by Antoine Savine (score 2)
https://quant.stackexchange.com/a/43061
It is only in models that guarantee positiveness of the stock price, like Black & Scholes, that an option of strike 0 is worth the spot. In other models, like Bachelier's model, where the distribution of the spot is Gaussian, the zero strike option is worth more than the stock.
## Answer by AFK (score 1)
https://quant.stackexchange.com/a/16195
You need to make a distinction between reality and the model you are considering.
1) In your model, the conclusion is valid: in your model holding the stock is equivalent to holding the zero strike call. This is because you make many implicit assumptions (basically these with zero risk free rate).
2) Yes these assumptions i.e. your model are very simplistic. No it doesn't take into account voting right or counterparty risk so you cannot expect the predictions of this model to match reality on these subjects. In fact it doesn't even take into account two much more important factors - interest rate - dividends (much more important that voting rights)Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.