Perpetual American Options [Loxx]

2022년 10월 4일

Perpetual American Options [Loxx] is Perpetual American Options pricing model. This indicator also includes numerical greeks.

American Perpetual Options
While there in general is no closed-form solution for American options (except for non-dividend-paying stock call options) it is possible to find a closed-form solution for options with an infinite time to expiration. The reason is that the time to expiration will always be the same: infinite. The time to maturity, therefore, does not depend on at what point in time we look at the valuation problem, which makes the valuation problem independent of time McKean (1965) and Merton (1973) gives closed-form solutions for American perpetual options. For a call option we have

c = (X / (y1 - 1)) * ((y1 - 1)/y1 * S/X)^y1

where

y1 = 1/2 - b/v^2 + ((b/v^2 - 1/2)^2 + 2*r/v^2)^0.5

If b >= r, then there is never optimal to exercise a call option. In the case of an American perpetual put, we have

p = X/(1-y2) * (((y2 - 1) / y2) * S/X)^y2

where

y2 = 1/2 - b/v^2 - ((b/v^2 - 1/2)^2 + 2*r/v^2)^0.5

In practice, one can naturally discuss if there is such a thing as infinite time to maturity. For instance, credit risk could play an important role: Even when you are buying an option from an AAA bank, there is no guarantee the bank will be around forever.

b=r options on non-dividend paying stock
b=r-q options on stock or index paying a dividend yield of q
b=0 options on futures
b=r-rf currency options (where rf is the rate in the second currency)

Inputs
S = Stock price.
K = Strike price of option.
T = Time to expiration in years.
r = Risk-free rate
c = Cost of Carry
V = Variance of the underlying asset price
cnd1(x) = Cumulative Normal Distribution
cbnd3(x) = Cumulative Bivariate Normal Distribution
nd(x) = Standard Normal Density Function
convertingToCCRate(r, cmp ) = Rate compounder

Numerical Greeks or Greeks by Finite Difference
Analytical Greeks are the standard approach to estimating Delta, Gamma etc... That is what we typically use when we can derive from closed form solutions. Normally, these are well-defined and available in text books. Previously, we relied on closed form solutions for the call or put formulae differentiated with respect to the Black Scholes parameters. When Greeks formulae are difficult to develop or tease out, we can alternatively employ numerical Greeks - sometimes referred to finite difference approximations. A key advantage of numerical Greeks relates to their estimation independent of deriving mathematical Greeks. This could be important when we examine American options where there may not technically exist an exact closed form solution that is straightforward to work with. (via VinegarHill FinanceLabs)

Things to know

• Only works on the daily timeframe and for the current source price.
  
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