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Valuation Of Options On Oil Futures Under The 3/4 Oil Price Model

Author

Listed:
  • MOHAMMED A. ABA OUD

    (Department of Mathematics and Statistics, Al Imam Mohammad Ibn Saud Islamic University (IMSIU), Riyadh, Kingdom of Saudi Arabia)

  • JOANNA GOARD

    (School of Mathematics and Applied Statistics, University of Wollongong, Northfields Ave, Wollongong 2522, NSW, Australia)

Abstract

Recently, an empirically-validated one-factor model with a 3/4-power diffusion term was introduced in the literature to model oil prices and value futures contracts on oil. In this paper, we provide an exact and analytic approximation for European call option prices on futures under a 3/4-power futures model. The analytic approximation, valid for short times to expiry is then calibrated to market prices. Results from the calibration show that the analytic approximation formula outperforms current popular options on futures formulae in capturing market prices.

Suggested Citation

  • Mohammed A. Aba Oud & Joanna Goard, 2015. "Valuation Of Options On Oil Futures Under The 3/4 Oil Price Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 18(08), pages 1-12, December.
    • Handle: RePEc:wsi:ijtafx:v:18:y:2015:i:08:n:s0219024915500508
    DOI: 10.1142/S0219024915500508
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    References listed on IDEAS

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    1. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    3. Schwartz, Eduardo S, 1997. "The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-973, July.
    4. Mohammed A. Aba Oud & Joanna Goard, 2015. "Stochastic Models for Oil Prices and the Pricing of Futures on Oil," Applied Mathematical Finance, Taylor & Francis Journals, vol. 22(2), pages 189-206, April.
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