IDEAS home Printed from https://ideas.repec.org/a/wsi/ijtafx/v15y2012i01ns0219024911006474.html
   My bibliography  Save this article

Target Volatility Option Pricing

Author

Listed:
  • GIUSEPPE DI GRAZIANO

    (Deutsche Bank AG, UK;
    Department of Mathematics, King's College London, Strand, London, WC2R 2LS, UK)

  • LORENZO TORRICELLI

    (Department of Mathematics, University College London, Gower Street, London, WC1E 6BT, UK)

Abstract

In this paper we present two methods for the pricing of Target Volatility Options (TVOs), a recent market innovation in the field of volatility derivative. TVOs allow investors to take a joint view on the future price of a given underlying (e.g. stocks, commodities, etc) and its realized volatility. For example, a target volatility call pays at maturity the terminal value of the asset minus the strike, floored at zero, scaled by the ratio of the target volatility (an arbitrary constant) and the realized volatility of the underlying over the life of the option. TVOs are popular with investors and hedgers because they are typically cheaper than their vanilla equivalent. We present two approaches for the pricing of TVOs: a power series expansion and a Laplace transform method. We also provide both model dependent and model independent solutions. The pricing methodologies have been tested numerically and results are provided.

Suggested Citation

  • Giuseppe Di Graziano & Lorenzo Torricelli, 2012. "Target Volatility Option Pricing," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(01), pages 1-17.
    • Handle: RePEc:wsi:ijtafx:v:15:y:2012:i:01:n:s0219024911006474
    DOI: 10.1142/S0219024911006474
    as

    Download full text from publisher

    File URL: http://www.worldscientific.com/doi/abs/10.1142/S0219024911006474
    Download Restriction: Access to full text is restricted to subscribers
    File URL: https://libkey.io/10.1142/S0219024911006474?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Arturo Estrella, 1995. "Taylor, Black and Scholes: series approximations and risk management pitfalls," Research Paper 9501, Federal Reserve Bank of New York.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Wang, Xingchun, 2021. "Pricing volatility-equity options under the modified constant elasticity of variance model," Finance Research Letters, Elsevier, vol. 38(C).
    2. Hongkai Cao & Alexandru Badescu & Zhenyu Cui & Sarath Kumar Jayaraman, 2020. "Valuation of VIX and target volatility options with affine GARCH models," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(12), pages 1880-1917, December.
    3. Lorenzo Torricelli, 2016. "Valuation of asset and volatility derivatives using decoupled time-changed Lévy processes," Review of Derivatives Research, Springer, vol. 19(1), pages 1-39, April.
    4. Elisa Alos & Rupak Chatterjee & Sebastian Tudor & Tai-Ho Wang, 2018. "Target volatility option pricing in lognormal fractional SABR model," Papers 1801.08215, arXiv.org.
    5. Roberto Daluiso & Emanuele Nastasi & Andrea Pallavicini & Stefano Polo, 2021. "Reinforcement learning for options on target volatility funds," Papers 2112.01841, arXiv.org.
    6. Ma, Jingtang & Li, Wenyuan & Han, Xu, 2015. "Stochastic lattice models for valuation of volatility options," Economic Modelling, Elsevier, vol. 47(C), pages 93-104.
    7. Wang, Xingchun, 2016. "Catastrophe equity put options with target variance," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 79-86.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Michel Aglietta, 1996. "Financial Market Failures and Systemic Risk," Working Papers 1996-01, CEPII research center.
    2. Matthew Pritsker, 1996. "Evaluating Value-at-Risk Methodologies: Accuracy versus Computational Time," Center for Financial Institutions Working Papers 96-48, Wharton School Center for Financial Institutions, University of Pennsylvania.
    3. P.J.G. Vlaar, 1996. "Methods to determine capital requirements for options," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 49(198), pages 351-373.
    4. Patricia Jackson & David Maude & William Perraudin, 1998. "Bank Capital and Value at Risk," Bank of England working papers 79, Bank of England.
    5. Michele Mininni & Giuseppe Orlando & Giovanni Taglialatela, 2021. "Challenges in approximating the Black and Scholes call formula with hyperbolic tangents," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 44(1), pages 73-100, June.
    6. Jean-Philippe Aguilar, 2018. "On expansions for the Black-Scholes prices and hedge parameters," Papers 1809.06736, arXiv.org, revised Jun 2019.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wsi:ijtafx:v:15:y:2012:i:01:n:s0219024911006474. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Tai Tone Lim (email available below). General contact details of provider: http://www.worldscinet.com/ijtaf/ijtaf.shtml .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.