Option pricing
Switching off to save cash
High electricity price volatility over the European summer has raised awareness of interruptible power contracts, finds James Ockenden
To store or not to store
Here we describe the optimal operation and valuation of gas storage based on a real option methodology. Using Zeebrugge gas prices as a practical example, Cyriel de Jong and Kasper Walet clarify the optionality in gas storage, analyse its valuation and…
Real option valuation and equity markets
Many non-financial assets can be viewed as ‘real options’ linked to some underlying variable such as a commodity price. Here, Thomas Dawson and Jennifer Considine show that the stock price of a well-known electricity generating company is significantly…
Enough’s enough
Brett Humphreys takes the guesswork out of determining how many simulations are needed to calculate value-at-risk
Option pricing for power prices with spikes
European power prices are very volatile and subject to spikes, particularly in German and Dutch markets. Ronald Huisman and Cyriel de Jong examine the impact of spikes on option prices by comparing prices from a standard mean-reverting model and a regime…
Why be backward?
Originally developed as a tool for calibrating smile models, so-called forward methods can also be used to price options and derive Greeks. Here, Peter Carr and Ali Hirsa apply the technique to the pricing of continuously exercisable American-style put…
Dealing with discrete dividends
Over the past year, we have published several papers on the issue of options on stocks with discrete dividends. At least three distinct models are used by practitioners, involving trade-offs between accuracy and tractability. Here, Remco Bos, Alexander…
Mean-reverting smiles
Commodity markets such as crude oil exhibit mean reversion as well as option smiles. The authors construct a model suitable for pricing exotic options in these markets
Exotic spectra
Eigenfunction expansions can also be applied to finance. The method is particularly suited to barrier and Asian options, with convergence properties that compare favourably with Monte Carlo.
The need for hybrid models
In response to the above article, the authors argue that pure firm-value approaches to default prediction are fundamentally flawed.?
Black-Scholes goes hypergeometric
Claudio Albanese, Giuseppe Campolieti, Peter Carr and Alexander Lipton introduce a generalpricing formula that extends Black-Scholes and contains as particular cases most analyticallysolvable models in the literature, including the quadratic and the…
The effect of stock pinning upon option prices
The existence of standardised expiration dates for listed equity options affects the prices ofunderlying stocks close to these dates due to hedging activity. Here, Hari Krishnan and IzzyNelken demonstrate that the effect is significant in US markets and…
Hedge your Monte Carlo
While the traditional Black-Scholes approach to option pricing is appealing on groundsof both elegance and tractability, the assumptions underlying it are usually violated inreal markets. Here, Marc Potters, Jean-Philippe Bouchaud and Dragan Šestovic´…
Optional events and jumps
Black & Scholes (1973) made several simplifying assumptionsto derive their option pricing formula, amongthem that the price of the underlying asset follows a continuouslognormal random walk with constant volatility.However, most assets have dynamics more…