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A simple closed-form approximation for constant elasticity of variance spread options

Author

Listed:
  • C. F. Lo

    (Institute of Theoretical Physics and Department of Physics, The Chinese University of Hong Kong, Shatin, New Territories, Hong Kong)

  • X. F. Zheng

    (Institute of Theoretical Physics and Department of Physics, The Chinese University of Hong Kong, Shatin, New Territories, Hong Kong)

Abstract

By applying the Lie–Trotter operator splitting method and the idea of the WKB method, we have developed a simple, accurate and efficient analytical approximation for pricing the constant elasticity of variance (CEV) spread options. The derived option price formula bears a striking resemblance to Kirk’s formula of the Black–Scholes spread options. Illustrative numerical examples show that the proposed approximation is not only extremely fast and robust, but it is also remarkably accurate for typical volatilities and maturities of up to two years.

Suggested Citation

  • C. F. Lo & X. F. Zheng, 2020. "A simple closed-form approximation for constant elasticity of variance spread options," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 7(04), pages 1-13, December.
    • Handle: RePEc:wsi:ijfexx:v:07:y:2020:i:04:n:s2424786320500474
    DOI: 10.1142/S2424786320500474
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