Leveraged ETF implied volatilities from ETF dynamics

DOI10.1111/MAFI.12128MaRDI QIDQ5371136zbMATH OpenOpenAlexFDO

Authors Tim Leung, Matthew Lorig, Andrea Pascucci

Publication date 24 October 2017

Published in Mathematical Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1404.6792

zbMATH Keywords

implied volatilityimplied volatility scalingleveraged exchange-traded fundlocal-stochastic volatility

Mathematics Subject Classification ID

Applications of stochastic analysis (to PDEs, etc.) (60H30) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: The growth of the exhange-traded fund (ETF) industry has given rise to the trading of options written on ETFs and their leveraged counterparts {(LETFs)}. We study the relationship between the ETF and LETF implied volatility surfaces when the underlying ETF is modeled by a general class of local-stochastic volatility models. A closed-form approximation for prices is derived for European-style options whose payoff depends on the terminal value of the ETF and/or LETF. Rigorous error bounds for this pricing approximation are established. A closed-form approximation for implied volatilities is also derived. We also discuss a scaling procedure for comparing implied volatilities across leverage ratios. The implied volatility expansions and scalings are tested in three well-known settings: CEV, Heston and SABR.

Recommendations

• Implied volatility of leveraged ETF options
• Consistent pricing of options on leveraged ETFs
• Short-time expansions for call options on leveraged ETFs under exponential Lévy models with local volatility
• Model-driven statistical arbitrage on LETF option markets
• Path-dependence of leveraged ETF returns

Cited in

(13)

• Dissecting the tracking performance of regular and leveraged VIX ETPs
• Rational pricing of leveraged ETF expense ratios
• Leveraged exchange-traded funds. Price dynamics and options valuation
• Consistent pricing of options on leveraged ETFs
• Levy models and long correlations applied to the study of exchange traded funds
• Optimal static quadratic hedging
• Dynamic index tracking and risk exposure control using derivatives
• Short-time expansions for call options on leveraged ETFs under exponential Lévy models with local volatility
• Implied volatility of leveraged ETF options
• Model-driven statistical arbitrage on LETF option markets
• LONG-TERM GROWTH RATE OF EXPECTED UTILITY FOR LEVERAGED ETFs: MARTINGALE EXTRACTION APPROACH
• Robust replication of volatility and hybrid derivatives on jump diffusions
• Smart leverage? Rethinking the role of Leveraged Exchange Traded Funds in constructing portfolios to beat a benchmark

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