Theory says an American call should never be exercised early, except possibly just before an ex-dividend date. But the best market bid is frequently below intrinsic value for an in-the-money short maturity option. An American option can always be exercised to recover intrinsic value, while...

Equity options are not only an attractive trading vehicle due to the high leverage they offer, they also enable investors to trade their volatility expectations. With high-resolution option data, we analyze the volatility information embedded in index options with different moneyness and...

Under Black-Scholes (BS) assumptions, empirical volatility and risk neutral volatility are given by a single parameter, which captures all aspects of risk. Inverting the model to extract implied volatility from an option's market price gives the market's forecast of future empirical volatility....

Trading in options with a wide range of exercise prices and a single maturity allows a researcher to extract the market's risk-neutral density (RND) over the underlying price at expiration. The RND contains investors' beliefs about the true probabilities blended with their risk preferences, both...

Trading strategies and contingent claims with path-dependent returns are difficult to model analytically. Monte Carlo simulation, the standard solution technique, is computationally expensive and provides a solution only for the specific parameter values used in the simulation. We present an...

Trading strategies and contingent claims with path-dependent returns are difficult to model analytically. Monte Carlo simulation, the standard solution technique, is computationally expensive and provides a solution only for the specific parameter values used in the simulation. We present an...

In modern finance, the value of an active investment strategy is measured by comparingits performance against the benchmark of passively holding the market portfolio and the riskless asset. We wish to evaluate the marginal contribution of a theoretical derivatives pricing model in the same way,...

Applying modern option valuation theory requires the user to forecast the volatility of the underlying asset over the remaining life of the option, a formidable estimation problem for long maturity instruments. The standard statistical procedures using historical data are based on assumptions of...

Stock index futures and program trading are among the most important financial market innovations of the 1980s. This chapter surveys the literature and provides an overview of the somewhat controversial area of index arbitrage. We begin with a description of how index futures work, how they...

There has been much discussion of risks tied to trading in derivatives, with some well-informed objective observers arguing that derivatives risks are not significantly greater or different from those associated with traditional financial instruments. Financial risks are often broken down into...