Options with Combined Reset Rights on Strike and Maturity

25 Pages Posted: 2 Aug 2004

See all articles by Min Dai

Min Dai

National University of Singapore (NUS) - Department of Mathematics

Yue Kuen Kwok

Hong Kong University of Science & Technology - Department of Mathematics

Date Written: July 31, 2004

Abstract

Reset clauses on the strike price and maturity date are commonly found in derivative contracts, like insurance segregated funds, bonds and executive warrants. We analyze the optimal reset policy adopted by the holder of an option that possesses the reset rights on the strike price and date of maturity. The optimal reset policy relates closely to the temporal rate of change of the value of the new option received by the holder at the reset moment. The characterization of the optimal reset policy requires the solution of a free boundary value problem. As part of the solution procedure, we determine the critical asset price for a given time to expiry at which the holder chooses to activate the reset clause optimally. Depending on the specific nature of the reset clauses, the reset policies exhibit a wide variety of behaviors. We also manage to obtain analytic price formulas for several specific types of reset options.

Keywords: Option pricing, strike reset, maturity reset, optimal stopping

JEL Classification: G13

Suggested Citation

Dai, Min and Kwok, Yue Kuen, Options with Combined Reset Rights on Strike and Maturity (July 31, 2004). Available at SSRN: https://ssrn.com/abstract=571265 or http://dx.doi.org/10.2139/ssrn.571265

Min Dai

National University of Singapore (NUS) - Department of Mathematics ( email )

Singapore

Yue Kuen Kwok (Contact Author)

Hong Kong University of Science & Technology - Department of Mathematics ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

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