Do Transaction Costs Affect the Optimal Exercise Strategy for American Put Options? PDF Download
Are you looking for read ebook online? Search for your book and save it on your Kindle device, PC, phones or tablets. Download Do Transaction Costs Affect the Optimal Exercise Strategy for American Put Options? PDF full book. Access full book title Do Transaction Costs Affect the Optimal Exercise Strategy for American Put Options? by Norman Seeger. Download full books in PDF and EPUB format.
Author: Norman Seeger
Publisher:
ISBN:
Category :
Languages : en
Pages : 36
Get Book Here
Book Description
Empirical evidence shows that American put options are exercised less often than predicted by theory. The paper provides an explanation for this empirical phenomenon by analyzing the effect of transaction costs in the underlying on the optimal exercise strategy. Using a model which explicitly takes transaction costs into account, we show for a realistic parameterization that it maybe optimal to postpone the exercise of put options relative to the standard frictionless theory. This result is mainly driven by the fact that transaction costs increase the replication costs associated with the payoff of a put option, i.e., transaction costs increase the continuation value of a put option which leads to a smaller number of states in which exercising is optimal.
Author: Norman Seeger
Publisher:
ISBN:
Category :
Languages : en
Pages : 36
Get Book Here
Book Description
Empirical evidence shows that American put options are exercised less often than predicted by theory. The paper provides an explanation for this empirical phenomenon by analyzing the effect of transaction costs in the underlying on the optimal exercise strategy. Using a model which explicitly takes transaction costs into account, we show for a realistic parameterization that it maybe optimal to postpone the exercise of put options relative to the standard frictionless theory. This result is mainly driven by the fact that transaction costs increase the replication costs associated with the payoff of a put option, i.e., transaction costs increase the continuation value of a put option which leads to a smaller number of states in which exercising is optimal.
Author: Valeriy Zakamulin
Publisher:
ISBN:
Category :
Languages : en
Pages : 40
Get Book Here
Book Description
In this paper we examine the problem of finding the reservation option prices and corresponding exercise policies of American options in a market with proportional transaction costs using the utility based approach proposed by Davis and Zariphopoulou (1995). We present a model where the option holder has a constant absolute risk aversion. We discuss the numerical algorithm and propose a new characterization of the option holder's value function. We suggest original discretization schemes for computing reservation prices and exercise policies of American options. The discretization schemes are implemented for the cases of American put and call options. We present the study of the optimal transaction policy of the option holder. We examine the effects on the reservation option prices and the corresponding exercise policies of varying the levels of absolute risk aversion and transaction costs.
Author: Malin Engstrom
Publisher:
ISBN:
Category :
Languages : en
Pages :
Get Book Here
Book Description
We investigate how well the actual exercise behaviour of American put options corresponds to the early exercise rules using Swedish equity option data. The numerical binomial model according to Cox et al. (1979) is used to compute a critical exercise price, above which a put option should be exercised early, in order to establish the theoretically optimal early exercise behaviour. We find several examples of irrational early exercise behaviour, both faulty actual exercises and failures to exercise. Most of the decisions to exercise the put options conform to rational exercise behaviour, whereas a large number of failures to exercise are found. This suggests that traders do not monitor their put option positions with sufficient care. By carrying out a sensitivity analysis, we conclude that the results persist after taking into account transaction costs associated with option exercise and the possibility that the volatility is not correctly estimated. A direct model-independent test of the failures to exercise, where the exercise value of the option is compared to its market bid price, shows that the results cannot be explained by the choice of model. Most of the found failures are regarded as failures also according to the direct test. Finally, we compute the average loss due to incorrect exercise behaviour in order to assess the economic significance of the results. Although occurring frequently, the failures to exercise do not appear to be costly.
Author: Tomasz Zastawniak
Publisher:
ISBN:
Category :
Languages : en
Pages : 24
Get Book Here
Book Description
American options are priced and hedged in a general discrete market in the presence of arbitrary proportional transaction costs inherent in trading the underlying asset, modelled as bid-ask spreads. Pricing, hedging and optimal stopping algorithms are established for a short position (seller's position) in an American option with an arbitrary payoff settled by physical delivery. The seller's price representation as the expectation of the stopped payoff under an approximate martingale measure is also considered. The algorithms cover and extend the various special cases considered in the literature to-date. Any specific restrictions that were imposed on the form of the payoff, the magnitude of transaction costs or the discrete market model itself are relaxed. The pricing algorithm under transaction costs can be viewed as a natural generalisation of the iterative Snell envelope construction.
Author: Wei Xing
Publisher:
ISBN:
Category :
Languages : en
Pages : 206
Get Book Here
Book Description
No analytical expression has been found for the optimal exercise boundary of finite maturity American put options. This thesis evaluates the performance of approximating the optimal boundary with a class of analytically tractable sub-optimal exercise boundaries which admit known first passage time density functions. The performance is evaluated in two steps, first by computing and comparing the value of the put option under the sub-optimal exercise policy to existing numerical approximation methods such as the binomial price, then by examining the profit/loss of a trader that would result from hedging and trading strategies based on the suboptimal exercise policy. We discovered that the valuation results from sub-optimal boundary exercise is very close to the binomial price. A closed form expression for the delta of the American put under sub-optimal exercise is derived, and the formula is remarkably close to the true numerical delta at significantly reduced computational time.
Author: John C. Cox
Publisher: Prentice Hall
ISBN:
Category : Business & Economics
Languages : en
Pages : 518
Get Book Here
Book Description
Includes the first published detailed description of option exchange operations, the first published treatment using only elementary mathematics and the first step-by-step procedure for implementing the Black-Scholes formula in actual trading.
Author: Ulrich Strohmeier
Publisher:
ISBN: 9783258068701
Category :
Languages : en
Pages : 52
Get Book Here
Book Description
Author: Richard M. Bookstaber
Publisher: McGraw-Hill Companies
ISBN:
Category : Business & Economics
Languages : en
Pages : 330
Get Book Here
Book Description
Author: Arun Chockalingam
Publisher:
ISBN:
Category :
Languages : en
Pages : 24
Get Book Here
Book Description
The optimal-exercise policy of an American option dictates when the option should be exercised. In this paper, we consider the implications of missing the optimal exercise time of an American option. For the put option, this means holding the option until it is deeper in-the-money when the optimal decision would have been to exercise instead. We derive an upper bound on the maximum possible loss incurred by such an option holder. This upper bound requires no knowledge of the optimal-exercise policy or true price function. This upper bound is a function of only the option-holders exercise strategy and the intrinsic value of the option. We show that this result holds true for both put and call options under a variety of market models ranging from the simple Black-Scholes model to complex stochastic-volatility jump-diffusion models. Numerical illustrations of this result are provided. We then use this result to study numerically how the cost of delaying exercise varies across market models and call and put options. We also use this result as a tool to numerically investigate the relation between an option-holders risk-preference levels and the maximum possible loss he may incur when adopting a target-payoff policy that is a function of his risk-preference level.
Author: Patrick Boyle
Publisher: Walter de Gruyter GmbH & Co KG
ISBN: 1547401214
Category : Business & Economics
Languages : en
Pages : 298
Get Book Here
Book Description
Trading and Pricing Financial Derivatives is an introduction to the world of futures, options, and swaps. Investors who are interested in deepening their knowledge of derivatives of all kinds will find this book to be an invaluable resource. The book is also useful in a very applied course on derivative trading. The authors delve into the history of options pricing; simple strategies of options trading; binomial tree valuation; Black-Scholes option valuation; option sensitivities; risk management and interest rate swaps in this immensely informative yet easy to comprehend work. Using their vast working experience in the financial markets at international investment banks and hedge funds since the late 1990s and teaching derivatives and investment courses at the Master's level, Patrick Boyle and Jesse McDougall put forth their knowledge and expertise in clearly explained concepts. This book does not presuppose advanced mathematical knowledge, though it is presented for completeness for those that may benefit from it, and is designed for a general audience, suitable for beginners through to those with intermediate knowledge of the subject.
