Third-order short-time expansions for close-to-the-money option prices under the CGMY model

A third-order approximation for close-to-the-money European option prices under an infinite-variation CGMY Lévy model is derived, and is then extended to a model with an additional independent Brownian component. The asymptotic regime considered, in which the strike is made to converge to the spot stock price as the maturity approaches zero, is relevant in applications since the most liquid options have strikes that are close to the spot price. Our results shed new light on the connection between both the volatility of the continuous component and the jump parameters and the behaviour of option prices near expiration when the strike is close to the spot price. In particular, a new type of transition phenomenon is uncovered in which the third-order term exhibits two distinct asymptotic regimes depending on whether $$Y \in (1,3/2)$$Y∈(1,3/2) or $$Y \in (3/2,2)$$Y∈(3/2,2) . Unlike second-order approximations, the expansions herein are shown to be remarkably accurate so that they can actually be used for calibrating some model parameters. For illustration, we calibrate the volatility $$\sigma $$σ of the Brownian component and the jump intensity C of the CGMY model to actual option prices.