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Book part
Publication date: 11 December 2006

Mo Chaudhury

This paper provides a fuller characterization of the analytical upper bounds for American options than has been available to date. We establish properties required of analytical…

Abstract

This paper provides a fuller characterization of the analytical upper bounds for American options than has been available to date. We establish properties required of analytical upper bounds without any direct reliance on the exercise boundary. A class of generalized European claims on the same underlying asset is then proposed as upper bounds. This set contains the existing closed form bounds of Margrabe, (1978) and Chen and Yeh (2002) as special cases and allows randomization of the maturity payoff. Owing to the European nature of the bounds, across-strike arbitrage conditions on option prices seem to carry over to the bounds. Among other things, European option spreads may be viewed as ratio positions on the early exercise option. To tighten the upper bound, we propose a quasi-bound that holds as an upper bound for most situations of interest and seems to offer considerable improvement over the currently available closed form bounds. As an approximation, the discounted value of Chen and Yeh's (2002) bound holds some promise. We also discuss implications for parametric and nonparametric empirical option pricing. Sample option quotes for the European (XEO) and the American (OEX) options on the S&P 100 Index appear well behaved with respect to the upper bound properties but the bid–ask spreads are too wide to permit a synthetic short position in the early exercise option.

Details

Research in Finance
Type: Book
ISBN: 978-1-84950-441-6

Article
Publication date: 20 April 2010

Peter Klein and Jun Yang

The purpose of this paper is to extend the models of Johnson and Stulz, Klein and Klein and lnglis to analyse the properties of vulnerable American options.

Abstract

Purpose

The purpose of this paper is to extend the models of Johnson and Stulz, Klein and Klein and lnglis to analyse the properties of vulnerable American options.

Design/methodology/approach

The presented model allows default prior to the maturity of the option based on a barrier which is linked to the payoff on the option. Various measures of risk denoted by the standard Greek letters are studied, as well as additional measures that arise because of the vulnerability.

Findings

The paper finds that the delta of a vulnerable American put does not always increase with the price of the underlying asset, and may be significantly smaller than that of a non‐vulnerable put. Because of deadweight costs associated with bankruptcy, delta and gamma are undefined for some values of the underlying asset. Rho may be considerably higher while vega may be smaller than for non‐vulnerable options. Also, the probability of early exercise for vulnerable American options is higher and the price of the underlying asset at which this is optimal depends on the degree of credit risk of the option writer.

Originality/value

This paper makes a contribution to understanding the effect of credit risk on option valuation.

Details

Managerial Finance, vol. 36 no. 5
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 10 April 2017

Rajesh Pathak, Satish Kumar and Ranajee Ranajee

The purpose of this paper is to examine the cross-sectional predictive power and the information content of volatility smirks for future stock returns using single stock options.

Abstract

Purpose

The purpose of this paper is to examine the cross-sectional predictive power and the information content of volatility smirks for future stock returns using single stock options.

Design/methodology/approach

The study uses Fama-Macbeth procedure and portfolio approach to investigate the predictability and informativeness in a setup when options settlement style is changed from American to European.

Findings

The study reports that the volatility smirk of European style options, unlike American style options, predict the underlying cross-sectional equity returns. Firms with steepest volatility smirk underperform firms with flatter volatility smirks, by an average of 3.28 and 4.01 per cent annually for American and European options, respectively. The results are robust to the control of idiosyncratic and systematic risk factors.

Practical implications

The results confirm that a trader with negative information prefers to trade out-of-the-money put options. The more pronounced results of European options designate the trader’s preference to less risky European style stock options. Results are robust and signify the delay of equity market in incorporating information impounded in the volatility smirk.

Originality/value

Very few studies examine smirk and returns relationship and to the best of the authors’ knowledge, no study exists that examine the unique case of change in options style and its role in affecting relationship between smirk and future returns.

Details

Managerial Finance, vol. 43 no. 4
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 1 October 1995

Roger P. Bey and Larry J. Johnson

The executive stock option (ESO) valuation model developed in this research amends the popular exchange traded option pricing models such as Black and Scholes (1973), Whaley…

Abstract

The executive stock option (ESO) valuation model developed in this research amends the popular exchange traded option pricing models such as Black and Scholes (1973), Whaley (1981), and Cox, Ross, and Rubinstein (1979) to include economic features of the ESO contract that previously have been ignored. One of these features is the non‐transferability of the ESO, which creates a situation where the ESO might be exercised when an otherwise identical exchange traded option would not. Another feature is the hybrid nature of the ESO; it is not solely either an American option or a European option. The results of the comparative statics indicate that the impact of the non‐transferability of the ESO value is significant, whereas the hybrid feature of the ESO results in values that are very similar to American option values. The economic implication is that if an American or European option model is used to value ESO's, the probability is very high that a wealth transfer between management and shareholders will occur.

Details

Managerial Finance, vol. 21 no. 10
Type: Research Article
ISSN: 0307-4358

Article
Publication date: 13 March 2009

Hsuan‐Ku Liu and Ming Long Liu

This paper sets out to consider the problem that the initial value of the American option is less than its fair price; this implies that the replication portfolio does not exist…

450

Abstract

Purpose

This paper sets out to consider the problem that the initial value of the American option is less than its fair price; this implies that the replication portfolio does not exist in the market.

Design/methodology/approach

The paper develops an optimization model whose solution provides an optimal strategy for the writer to minimize the expected loss for this problem.

Findings

The numerical results reveal that loaning money to construct a replication portfolio may not be an optimal strategy for the writer.

Practical implications

The solution of the minimum expected loss model provides an optimal strategy to construct a lower expected loss portfolio.

Originality/value

The numerical results reveal that loaning money to construct a replication portfolio may not be an optimal strategy for the writer.

Details

Journal of Modelling in Management, vol. 4 no. 1
Type: Research Article
ISSN: 1746-5664

Keywords

Abstract

Details

Energy Power Risk
Type: Book
ISBN: 978-1-78743-527-8

Article
Publication date: 9 July 2020

Mohammad Vahdatmanesh and Afshin Firouzi

Steel price uncertainty exposes pipeline projects that are inherently capital intensive to the risk of cost overruns. The current study proposes a hedging methodology for tackling…

Abstract

Purpose

Steel price uncertainty exposes pipeline projects that are inherently capital intensive to the risk of cost overruns. The current study proposes a hedging methodology for tackling steel pipeline price risk by deploying Asian option contracts that address the shortcomings of current risk mitigation strategies.

Design/methodology/approach

A stepwise methodology is introduced, which uses a closed-form formula as an Asian option valuation method for calculating this total expenditure. The scenario analysis of three price trends examines whether or not the approach is beneficial to users. The sensitivity analysis then has been conducted using the financial option Greeks to assess the effects of changes in volatility in the total price of the option contracts. The total price of the Asian options was then compared with those of the European and American options.

Findings

The results demonstrate that the Asian option expenditure was about 1.87% of the total cost of the case study project. The scenario analysis revealed that, except for when the price followed a continuous downward pattern, the use of this type of financial instrument is a practical approach for steel pipeline price risk management.

Practical implications

This approach is founded on a well-established financial options theory and elucidates how pipeline project participants can deploy Asian option contracts to safeguard against steel price fluctuations in practice.

Originality/value

Although the literature exists about the theory and application of financial derivative instruments for risk management in other sectors, their application to the construction industry is infrequent. In the proposed methodology, all participants involved in fixed price pipeline projects readily surmount the risk of exposure to material price fluctuations.

Details

Engineering, Construction and Architectural Management, vol. 27 no. 10
Type: Research Article
ISSN: 0969-9988

Keywords

Book part
Publication date: 10 December 2018

George Levy

Abstract

Details

Energy Power Risk
Type: Book
ISBN: 978-1-78743-527-8

Content available
Book part
Publication date: 10 December 2018

George Levy

Abstract

Details

Energy Power Risk
Type: Book
ISBN: 978-1-78743-527-8

Article
Publication date: 21 November 2023

Patrice Gaillardetz and Saeb Hachem

By using higher moments, this paper extends the quadratic local risk-minimizing approach in a general discrete incomplete financial market. The local optimization subproblems are…

Abstract

Purpose

By using higher moments, this paper extends the quadratic local risk-minimizing approach in a general discrete incomplete financial market. The local optimization subproblems are convex or nonconvex, depending on the moment variants used in the modeling. Inspired by Lai et al. (2006), the authors propose a new multiobjective approach for the combination of moments that is transformed into a multigoal programming problem.

Design/methodology/approach

The authors evaluate financial derivatives with American features using local risk-minimizing strategies. The financial structure is in line with Schweizer (1988): the market is discrete, self-financing is not guaranteed, but deviations are controlled and reduced by minimizing the second moment. As for the quadratic approach, the algorithm proceeds backwardly.

Findings

In the context of evaluating American option, a transposition of this multigoal programming leads not only to nonconvex optimization subproblems but also to the undesirable fact that local zero deviations from self-financing are penalized. The analysis shows that issuers should consider some higher moments when evaluating contingent claims because they help reshape the distribution of global cumulative deviations from self-financing.

Practical implications

A detailed numerical analysis that compares all the moments or some combinations of them is performed.

Originality/value

The quadratic approach is extended by exploring other higher moments, positive combinations of moments and variants to enforce asymmetry. This study also investigates the impact of two types of exercise decisions and multiple assets.

Details

Studies in Economics and Finance, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1086-7376

Keywords

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