Pricing and Hedging Options on Assets with Options on Related Assets
26 Pages Posted: 28 Jul 2020
Date Written: July 2, 2020
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: Suggested Citation