A Replicating Portfolio Approach to Valuing American Options in Closed-Form

12 Pages Posted: 9 Jan 2021 Last revised: 19 Feb 2021

See all articles by Muhammad Nazmul Khan

Muhammad Nazmul Khan

Ahsanullah University of Science & Technology; East West University

Date Written: November 19, 2020

Abstract

I derive closed-form expressions for the value of American call and put options (on an asset with continuous yield) using the Feynman-Kac formula, modelling the size of early exercise premium as a function of the strike, dividend yield and time to maturity. Strategies involving European options and binary options on forwards on the asset replicate an American option exactly. Violations of Put-Call parity for American options is also explored in this framework.

Keywords: Rational Pricing, American Options, Static Replicating Portfolio

JEL Classification: C32, G13

Suggested Citation

Khan, Muhammad, A Replicating Portfolio Approach to Valuing American Options in Closed-Form (November 19, 2020). Available at SSRN: https://ssrn.com/abstract=3733258 or http://dx.doi.org/10.2139/ssrn.3733258

Muhammad Khan (Contact Author)

Ahsanullah University of Science & Technology ( email )

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Tejgaon Industrial Area, Dhaka 1208
Dhaka, 1208
Bangladesh

East West University ( email )

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Dhaka, Dhaka 1217
Bangladesh

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