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The Bachelier Model: Option Pricing with Negative Strike and Asset Price

In: The CME Vulnerability The Impact of Negative Oil Futures Trading

Author

Listed:
  • You Zhang
  • Lingtong (Stanley) Meng

Abstract

On April 20, for the first time in history, a major oil future, West Texas Intermediate (WTI) May contract, closed below zero, raising alerts among market participants and regulators on the real possibility of negative prices, which is not a standard assumption when pricing derivatives outside the fixed income market. Following the event, the Chicago Mercantile Exchange (CME) announced that the Bachelier model would be used instead of the standard Black–Scholes model accounting for pricing negative strike options. In this paper, we first compare the two models and highlight their key technical differences; then we present the potential implications caused by model switching on derivatives pricing, risk management, and market structure from a practitioner’s point of view; lastly, we discuss some practical points the regulator should be noting when considering to modify the current regulatory framework.

Suggested Citation

  • You Zhang & Lingtong (Stanley) Meng, 2020. "The Bachelier Model: Option Pricing with Negative Strike and Asset Price," World Scientific Book Chapters, in: George Xianzhi Yuan (ed.), The CME Vulnerability The Impact of Negative Oil Futures Trading, chapter 11, pages 215-222, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789811223204_0011
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    More about this item

    Keywords

    CME; Vulnerability; WTI; Oil; Trading; Rule; 420; Negative Trading Price; Best Practice; Valuation; Risk Management; Regulatory; Rule; Accounting; Standard; Fair Value; Trading Behaviour; Covid; Corona;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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