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further limits the risk to an investor, because the price
differential between the legs of one spread would have to change
with respect to the price differential of the legs of the other
spread before there would be a net economic effect.
(1) Merit's Nominal Pricing Formula
Because there was no publicly traded T-bill options market,
Dr. Richartz engaged Dr. Leonard Auerbach to develop a pricing
system for the options. Dr. Auerbach has taught at the University
of California at Berkeley, the University of Southern California,
and St. Mary's College. Dr. Auerbach adapted the Black-Scholes
model formula for pricing stock options as the basis for devising
a pricing formula for Merit's T-bill and T-bond options. The
Black-Scholes formula determines stock option values on the basis
of the price of the underlying security, the length of the option,
the strike price, the risk-free interest rate, and volatility. See
Black & Scholes, "The Pricing of Options and Corporate
Liabilities", 81 J. Pol. Econ. 637 (1973). Dr. Auerbach developed
and repeatedly revised a formula for Merit which could be used to
calculate a price estimated to be equal to the price that would
have applied in an open market.
(2) Merit's Income Structure
Merit earned income from operating its option markets in two
ways. First, it collected a bid/ask differential on opening
positions. The bid/ask is the difference between the price a
dealer will pay for an item and the price at which he will sell
that item. The difference between the price paid to purchase an
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