Journal ArticleDOI
Pricing and Hedging Spread Options
René Carmona,Valdo Durrleman +1 more
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TLDR
This work presents a general overview of the common features of all spread options by discussing in detail their roles as speculation devices and risk management tools, and describes the mathematical framework used to model them.Abstract:
We survey theoretical and computational problems associated with the pricing and hedging of spread options. These options are ubiquitous in the financial markets, whether they be equity, fixed income, foreign exchange, commodities, or energy markets. As a matter of introduction, we present a general overview of the common features of all spread options by discussing in detail their roles as speculation devices and risk management tools. We describe the mathematical framework used to model them, and we review the numerical algorithms actually used to price and hedge them. There is already extensive literature on the pricing of spread options in the equity and fixed income markets, and our contribution is mostly to put together material scattered across a wide spectrum of recent textbooks and journal articles. On the other hand, information about the various numerical procedures that can be used to price and hedge spread options on physical commodities is more difficult to find. For this reason, we make a systematic effort to choose examples from the energy markets in order to illustrate the numerical challenges associated with these instruments. This gives us a chance to discuss an interesting application of spread options to an asset valuation problem after it is recast in the framework of real options. This approach is currently the object of intense mathematical research. In this spirit, we review the two major avenues to modeling energy price dynamics. We explain how the pricing and hedging algorithms can be implemented in the framework of models for both the spot price dynamics and the forward curve dynamics.read more
Citations
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Journal ArticleDOI
An Approximate Dynamic Programming Approach to Benchmark Practice-Based Heuristics for Natural Gas Storage Valuation
TL;DR: A novel and tractable approximate dynamic programming method is developed that, coupled with Monte Carlo simulation, computes lower and upper bounds on the value of storage and finds that these heuristics are extremely fast to execute but significantly suboptimal compared to the upper bound.
Journal ArticleDOI
A Fourier Transform Method for Spread Option Pricing
Thomas R. Hurd,Zhuowei Zhou +1 more
TL;DR: In this paper, a new formula for general spread option pricing based on Fourier analysis of the payoff function is introduced, which is easy to implement, stable, efficient, and applicable in a wide variety of asset pricing models.
Journal ArticleDOI
Fourier Space Time-Stepping for Option Pricing With Levy Models
TL;DR: In this article, the authors present a transform-based approach to solve the partial-integro differential equation (PIDE) problem for a wide class of path-dependent options (such as Bermudan, barrier, and shout options).
Book ChapterDOI
A Survey of Commodity Markets and Structural Models for Electricity Prices
René Carmona,Michael Coulon +1 more
TL;DR: In this article, a survey of the major idiosyncrasies of commodity markets and the methods which have been proposed to handle them in spot and forward price models is presented, focusing on the most idiosyncratic of all: electricity markets.
Journal ArticleDOI
Forecasting oil price movements with crack spread futures
Atilim Murat,Ekin Tokat +1 more
TL;DR: In this paper, the authors investigated the causal relationship between crack spread futures and the spot oil markets in a vector error correction framework and found that both the crack spread and the crude oil futures outperformed the RWM.
References
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Journal ArticleDOI
The Pricing of Options and Corporate Liabilities
Fischer Black,Myron S. Scholes +1 more
TL;DR: In this paper, a theoretical valuation formula for options is derived, based on the assumption that options are correctly priced in the market and it should not be possible to make sure profits by creating portfolios of long and short positions in options and their underlying stocks.
Book
Theory of rational option pricing
TL;DR: In this paper, the authors deduced a set of restrictions on option pricing formulas from the assumption that investors prefer more to less, which are necessary conditions for a formula to be consistent with a rational pricing theory.
Journal ArticleDOI
A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options
TL;DR: In this paper, a closed-form solution for the price of a European call option on an asset with stochastic volatility is derived based on characteristi c functions and can be applied to other problems.
Book
Options, Futures, and Other Derivatives
TL;DR: The Black-Scholes analysis of stock option prices was used in this paper to model the behavior of stock prices and the Yield Curve of stock options, as well as the Black's model for option pricing.
Journal ArticleDOI
Option pricing when underlying stock returns are discontinuous
TL;DR: In this article, an option pricing formula was derived for the more general case when the underlying stock returns are generated by a mixture of both continuous and jump processes, and the derived formula has most of the attractive features of the original Black-Scholes formula.