Optimal timing to purchase options

DOI10.1137/100809386MaRDI QIDQ5388685zbMATH OpenOpenAlexFDO

Authors Tim Leung, Michael Ludkovski

Publication date 19 April 2012

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

Full work available at URL https://arxiv.org/abs/1008.3650

zbMATH Keywords

delayed purchase premiumoptimal stoppingprice discrepancyrisk premia

Mathematics Subject Classification ID

Stopping times; optimal stopping problems; gambling theory (60G40) Derivative securities (option pricing, hedging, etc.) (91G20) Financial applications of other theories (91G80)

Abstract: We study the optimal timing of derivative purchases in incomplete markets. In our model, an investor attempts to maximize the spread between her model price and the offered market price through optimally timing her purchase. Both the investor and the market value the options by risk-neutral expectations but under different equivalent martingale measures representing different market views. The structure of the resulting optimal stopping problem depends on the interaction between the respective market price of risk and the option payoff. In particular, a crucial role is played by the delayed purchase premium that is related to the stochastic bracket between the market price and the buyer's risk premia. Explicit characterization of the purchase timing is given for two representative classes of Markovian models: (i) defaultable equity models with local intensity; (ii) diffusion stochastic volatility models. Several numerical examples are presented to illustrate the results. Our model is also applicable to the optimal rolling of long-dated options and sequential buying and selling of options.

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