Pricing and Hedging Options on Assets with Options on Related Assets

26 Pages Posted: 28 Jul 2020

See all articles by Dilip B. Madan

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business

King Wang

Morgan Stanley

Date Written: July 2, 2020

Abstract

The problem studied is the pricing of options on the CBOE Skew index. The option pricing theory developed seeks to hedge the risk using positions in the market for options on a related asset and the option is then priced at the cost of this hedge. The theory is applied to pricing VIX options using the market for SPY options and pricing options on JPM using the market for XLF options. The approach is then applied to illustrate the pricing of CBOE Skew Index options using the market for SPY options. The Skew Index smile is then seen to imply the VIX and SKEW of the Skew Index itself.

Keywords: Multivariate bilateral gamma, Gaussian and t-copula, Acceptable Risks, Distorted Expectations

JEL Classification: G10, G11, G12

Suggested Citation

Madan, Dilip B. and Wang, King, Pricing and Hedging Options on Assets with Options on Related Assets (July 2, 2020). Available at SSRN: https://ssrn.com/abstract=3641658 or http://dx.doi.org/10.2139/ssrn.3641658

Dilip B. Madan (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2127 (Phone)
301-314-9157 (Fax)

King Wang

Morgan Stanley ( email )

1585 Broadway
New York, NY 10036
United States

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