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Upper bounds for american futures options: A note

✍ Scribed by Mohammed M. Chaudhury; Jason Wei

Publisher
John Wiley and Sons
Year
1994
Tongue
English
Weight
264 KB
Volume
14
Category
Article
ISSN
0270-7314

No coin nor oath required. For personal study only.

✦ Synopsis

Under standard perfect market assumptions, the cost-of-carry formula can be applied to calculate the value of a pure (futures-style margining)

European futures option at time t with maturity at T [Duffie (1989, p. 285); Lieu (1990, p. 332)l:

where EC and EP are conventional European futures option prices for call and put, respectively, and are given by Black (1976) for lognormal futures prices. Pricing equations (1) and (2) apply to pure American call (PAC) and pure American put (PAP) options as well [Lieu (1990)I even if the interest rate is stochastic [Chen and Scott (1992)], since the pure European option price never falls below the intrinsic value of the option. Building on these pure options results and using rational pricing arguments [Merton ( 1 973)], new upper bounds for conventional American options are proposed in this note.

Thanks to two anonymous referees for valuable comments. The first author also acknowledges many helpful discussions with R. Chen.

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