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Closed-Form Approximations for Spread Option Prices and Greeks

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  • Li, Minqiang

Abstract

We develop a new closed-form approximation method for pricing spread options. Numerical analysis shows that our method is more accurate than existing analytical approximations. Our method is also extremely fast, with computing time more than two orders of magnitude shorter than one-dimensional numerical integration. We also develop closed-form approximations for the greeks of spread options. In addition, we analyze the price sensitivities of spread options and provide lower and upper bounds for digital spread options. Our method enables the accurate pricing of a bulk volume of spread options with different specifications in real time, which offers traders a potential edge in financial markets. The closed-form approximations of greeks serve as valuable tools in financial applications such as dynamic hedging and value-at-risk calculations.

Suggested Citation

  • Li, Minqiang, 2008. "Closed-Form Approximations for Spread Option Prices and Greeks," MPRA Paper 6994, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:6994
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    File URL: https://mpra.ub.uni-muenchen.de/6994/1/MPRA_paper_6994.pdf
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    References listed on IDEAS

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    2. Minqiang Li, 2008. "The impact of return nonnormality on exchange options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 28(9), pages 845-870, September.
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    Cited by:

    1. repec:wsi:ijfexx:v:04:y:2017:i:02n03:n:s2424786317500177 is not listed on IDEAS
    2. Carol Alexander & Aanand Venkatramanan, 2007. "Analytic Approximations for Spread Options," ICMA Centre Discussion Papers in Finance icma-dp2009-06, Henley Business School, Reading University, revised Jun 2009.
    3. Tommaso Paletta & Arturo Leccadito & Radu Tunaru, 2013. "Pricing and Hedging Basket Options with Exact Moment Matching," Papers 1312.4443, arXiv.org.
    4. Li, Minqiang & Mercurio, Fabio, 2013. "Closed-Form Approximation of Timer Option Prices under General Stochastic Volatility Models," MPRA Paper 47465, University Library of Munich, Germany.
    5. Leccadito, Arturo & Paletta, Tommaso & Tunaru, Radu, 2016. "Pricing and hedging basket options with exact moment matching," Insurance: Mathematics and Economics, Elsevier, vol. 69(C), pages 59-69.
    6. repec:kap:fmktpm:v:31:y:2017:i:4:d:10.1007_s11408-017-0301-4 is not listed on IDEAS
    7. Nicola Secomandi & Mulan X. Wang, 2012. "A Computational Approach to the Real Option Management of Network Contracts for Natural Gas Pipeline Transport Capacity," Manufacturing & Service Operations Management, INFORMS, vol. 14(3), pages 441-454, July.
    8. Jui‐Jane Chang & Son‐Nan Chen & Ting‐Pin Wu, 2013. "Currency‐Protected Swaps and Swaptions with Nonzero Spreads in a Multicurrency LMM," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 33(9), pages 827-867, September.
    9. Pablo Olivares & Matthew Cane, 2014. "Pricing Spread Options under Stochastic Correlation and Jump-Diffusion Models," Papers 1409.1175, arXiv.org.
    10. Pellegrino, Tommaso & Sabino, Piergiacomo, 2014. "On the use of the moment-matching technique for pricing and hedging multi-asset spread options," Energy Economics, Elsevier, vol. 45(C), pages 172-185.
    11. Elisa Alòs & Jorge A. León, 2013. "On the closed-form approximation of short-time random strike options," Economics Working Papers 1347, Department of Economics and Business, Universitat Pompeu Fabra.
    12. Alexander Kushpel, 2014. "Pricing of basket options I," Papers 1401.1856, arXiv.org.
    13. Minqiang Li & Jieyun Zhou & Shi-Jie Deng, 2010. "Multi-asset spread option pricing and hedging," Quantitative Finance, Taylor & Francis Journals, vol. 10(3), pages 305-324.
    14. Juan Arismendi, 2014. "A Multi-Asset Option Approximation for General Stochastic Processes," ICMA Centre Discussion Papers in Finance icma-dp2014-03, Henley Business School, Reading University.
    15. Olivares Pablo & Villamor Enrique, 2017. "Valuing Exchange Options Under an Ornstein-Uhlenbeck Covariance Model," Papers 1711.10013, arXiv.org.
    16. Nicola Cufaro Petroni & Piergiacomo Sabino, 2015. "Cointegrating Jumps: an Application to Energy Facilities," Papers 1509.01144, arXiv.org, revised Jul 2016.
    17. Alexander Kushpel, 2015. "Pricing of high-dimensional options," Papers 1510.07221, arXiv.org.
    18. Caldana, Ruggero & Fusai, Gianluca, 2013. "A general closed-form spread option pricing formula," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4893-4906.
    19. Nagy, Tamás, 2013. "A villamos erőművek szén-dioxid-kibocsátásának modellezése reálopciók segítségével
      [Modelling of the carbon dioxide emissions of a power plant, using real options]
      ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(3), pages 318-341.

    More about this item

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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