Analytic Approximations for Spread Options
Even in the simple case that two price processes follow correlated geometric Brownian motions with constant volatility no analytic formula for the price of a standard European spread option has been derived, except when the strike is zero in which case the option becomes an exchange option. This paper expresses the price of a spread option as the price of a compound exchange option and hence derives a new analytic approximation for its price and hedge ratios. This approximation has several advantages over existing analytic approximations, which have limited validity and an indeterminacy that renders them of little practical use. Simulations quantify the accuracy of our approach and demonstrate the indeterminacy and inaccuracy of other analytic approximations. The American spread option price is identical to the European option price when the two price processes have identical drifts, and otherwise we derive an expression for the early exercise premium. A practical illustration of the model calibration uses market data on American crack spread options.
|Date of creation:||Aug 2007|
|Contact details of provider:|| Postal: PO Box 218, Whiteknights, Reading, Berks, RG6 6AA|
Phone: +44 (0) 118 378 8226
Fax: +44 (0) 118 975 0236
Web page: http://www.henley.reading.ac.uk/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Li, Minqiang, 2008. "Closed-Form Approximations for Spread Option Prices and Greeks," MPRA Paper 6994, University Library of Munich, Germany.
When requesting a correction, please mention this item's handle: RePEc:rdg:icmadp:icma-dp2007-11. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marie Pearson)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.