Options on futures contracts: A comparison of European and American pricing models

✍ Scribed by Kuldeep Shastri; Kishore Tandon

• Publisher: John Wiley and Sons
• Year: 1986
• Tongue: English
• Weight: 775 KB
• Volume: 6
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.3990060407

✦ Synopsis

ecent theoretical research has developed two valuation models for pricing R options on futures contracts-a European version, and a more complex American variant. The purpose of this article is to compare the pricing behavior of the two models and develop some implications for the use of European models in the estimation of market prices. Our simulations and empirical tests show that the European model performs reasonably well for both call and put options on futures contracts.

I. INTRODUCTION

Since the beginning of 1983, options on nine different futures contracts have been traded on the Chicago Board of Trade, the Commodity Exchange, the Chicago Mercantile Exchange, the New York Futures Exchange, and the Coffee, Sugar, and Cocoa Exchange. The underlying futures contracts include T-bonds, gold, silver, the NYSE Composite Index, the S&P 500 Stock Index, the West German Mark, and Live Cattle.

The first author to deal with the valuation of options on futures contracts was Black (1976). He derives a pricing model for these options and shows that it is identical to the continuous dividend version of the Black-Scholes (1973) formula for equity options. As pointed out by Wolf (1984), this model has received widespread attention among professional traders, and is used by many of them as a benchmark for evaluations of options premiums. In addition, some of the commodities exchanges also use it to calculate margin requirements for floor traders.