Semistatic hedging and pricing American floating strike lookback options

San Lin Chung*, Yi Ta Huang, Pai Ta Shih, Jr Yan Wang

*Corresponding author for this work

Research output: Contribution to journalJournal Article peer-review

1 Scopus citations

Abstract

We price an American floating strike lookback option under the Black–Scholes model with a hypothetic static hedging portfolio (HSHP) composed of nontradable European options. Our approach is more efficient than the tree methods because recalculating the option prices is much quicker. Applying put–call duality to an HSHP yields a tradable semistatic hedging portfolio (SSHP). Numerical results indicate that an SSHP has better hedging performance than a delta-hedged portfolio. Finally, we investigate the model risk for SSHP under a stochastic volatility assumption and find that the model risk is related to the correlation between asset price and volatility.

Original languageEnglish
Pages (from-to)418-434
Number of pages17
JournalJournal of Futures Markets
Volume39
Issue number4
DOIs
StatePublished - 04 2019
Externally publishedYes

Bibliographical note

Publisher Copyright:
© 2018 Wiley Periodicals, Inc.

Keywords

  • American floating strike lookback option
  • dynamic hedging
  • model risk
  • put–call duality
  • semistatic hedging
  • stochastic volatility model

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