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pricing ITM options without ITM volatilities
Posted: October 26th, 2004, 2:47 pm
by dkkchan
It is commonly known that the FX option mkt trades 25D/10D Risk Reversals and 25D/10D Butterflies, hence able to build volatility surface to price other any vanilla type of options. Problem with this is only OTM (eg. 10delta/25delta) instruments are avaliable from the market. Well, evaluating ITM call (put) seems not so straight forward and can be solved by using OTM put (call) price/volatility due to put-call parity. But, if they are americans, how would i evaluate those ITM american options provided that they are not so deep in the money? (otherwise S-X or X-S will do the job)Kind Regardsdan
pricing ITM options without ITM volatilities
Posted: October 26th, 2004, 4:33 pm
by Val
One well-known approach is used in Energy derivatives market where often quoted prices (NYMEX) are given as american options on standard futures contracts.Here it is applied a forward induction method (Fokker-Planck PDE) such that it is calibrated to a given set of market prices (maturity/Strike).
pricing ITM options without ITM volatilities
Posted: October 26th, 2004, 11:54 pm
by dkkchan
Thanks for your inspiration, can you highlight some of the details or refer me to some references ... thxthxdan
pricing ITM options without ITM volatilities
Posted: October 27th, 2004, 5:24 am
by Val
For the frwd PDE method itself, you can read the following papers:-Calibration and Implementation of Convertible Bond ModelsLeif Andersen and Dan Buffum- A Note on Pricing weekly-path-dependent American-style Options by Backward Inductions-Risk Sensitivities of Bermuda SwaptionsVladimir PiterbargOtherwise- Mean-reverting smiles -Risk April 2002-A two-factor mean-reverting model -Risk July 2002David Beaglehole and Alain Chebanier