Valuing Seller-Defaultable Options

This study analyzes seller‐defaultable options that allow option writers to have a free‐will right to default, along with some prespecified default mechanisms. We analytically and numerically examine the pricing, hedging, defaulting, and profitability of the seller‐defaultable options, considering t...

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Bibliographic Details
Published inThe journal of futures markets Vol. 33; no. 2; pp. 129 - 157
Main Authors Lu, Jin-Ray, Chen, Yi-Chun, Hwang, Chih-Chiang, Ting, Yi-Chun
Format Journal Article
LanguageEnglish
Published Hoboken Blackwell Publishing Ltd 01.02.2013
Wiley Periodicals Inc
Subjects
Asset pricing
Default
Greece
Hedging
Interest rates
Options trading
Profit
Profitability
Stock prices
Studies
Volatility
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Summary:This study analyzes seller‐defaultable options that allow option writers to have a free‐will right to default, along with some prespecified default mechanisms. We analytically and numerically examine the pricing, hedging, defaulting, and profitability of the seller‐defaultable options, considering three possible scenarios for seller default. Analyzing the essential implications of seller‐defaultable options, we show that the option price is positively correlated with the default fine, underlying asset price, and volatility. The seller‐defaultable option's Greeks appear more complicated than those of the plain vanilla options. The likelihood of sellers defaulting increases with the underlying asset price, interest rate, volatility, and maturity time. Subject to the default mechanism, the buyers’ trading involves a trade‐off between profits and costs. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:129–157, 2013
Bibliography:ArticleID:FUT21542
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The authors would like to thank anonymous referees and the editor for their helpful comments. The authors alone remain responsible for any errors in connection with this work.
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ISSN:0270-7314
1096-9934
DOI:10.1002/fut.21542