Multi-asset spread option pricing and hedging
We provide two new closed-form approximation methods for pricing spread options on a basket of risky assets: the extended Kirk approximation and the second-order boundary approximation. The latter method generalizes the results in Li et al. [J. Deriv., 2008, 15, 58-80] to spread options on an arbitrary number of assets. Numerical analysis shows that while the latter method is more accurate than the former, both methods are extremely fast and accurate. Closed-form approximations for important Greeks are also derived. Our approximation methods enable the accurate pricing of a bulk volume of spread options on a large number of assets in real time, which offers traders a potential edge in a dynamic market environment.
Volume (Year): 10 (2010)
Issue (Month): 3 ()
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- Johnson, Shane A. & Tian, Yisong S., 2000. "Indexed executive stock options," Journal of Financial Economics, Elsevier, vol. 57(1), pages 35-64, July.
- Jarrow, Robert & Rudd, Andrew, 1982. "Approximate option valuation for arbitrary stochastic processes," Journal of Financial Economics, Elsevier, vol. 10(3), pages 347-369, November.
- Li, Minqiang, 2008. "Closed-Form Approximations for Spread Option Prices and Greeks," MPRA Paper 6994, University Library of Munich, Germany.
- Li, Minqiang, 2007. "The Impact of Return Nonnormality on Exchange Options," MPRA Paper 7020, University Library of Munich, Germany.
- Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-86, March.
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