Short-time expansions for call options on leveraged ETFs under exponential Lévy models with local volatility

DOI10.1137/17M1111292zbMATH Open1408.91213arXiv1608.07863OpenAlexW2963275658WikidataQ115525619 ScholiaQ115525619MaRDI QIDQ4635252FDOQ4635252

José E. Figueroa-López, Matthew Lorig, Ruoting Gong

Publication date: 16 April 2018

Published in: SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Abstract: In this article, we consider the small-time asymptotics of options on a emph{Leveraged Exchange-Traded Fund} (LETF) when the underlying Exchange Traded Fund (ETF) exhibits both local volatility and jumps of either finite or infinite activity. Our main results are closed-form expressions for the leading order terms of off-the-money European call and put LETF option prices, near expiration, with explicit error bounds. We show that the price of an out-of-the-money European call on a LETF with positive (negative) leverage is asymptotically equivalent, in short-time, to the price of an out-of-the-money European call (put) on the underlying ETF, but with modified spot and strike prices. Similar relationships hold for other off-the-money European options. In particular, our results suggest a method to hedge off-the-money LETF options near expiration using options on the underlying ETF. Finally, a second order expansion for the corresponding implied volatility is also derived and illustrated numerically.

Full work available at URL: https://arxiv.org/abs/1608.07863

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zbMATH Keywords

leveragelocal volatilityimplied volatilitysmall-time asymptoticsETFLévy models

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Derivative securities (option pricing, hedging, etc.) (91G20) Asymptotic approximations, asymptotic expansions (steepest descent, etc.) (41A60)

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Cited In (5)

• The economics of time as it is embedded in the prices of options§
• Robust long-term growth rate of expected utility for leveraged ETFs
• LONG-TERM GROWTH RATE OF EXPECTED UTILITY FOR LEVERAGED ETFs: MARTINGALE EXTRACTION APPROACH
• Model-driven statistical arbitrage on LETF option markets
• Short-time implied volatility of additive normal tempered stable processes

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