Pricing bond futures options
From bonk fixed income securities 3rd by Tuckman, I understand how to pricing European option on bond future, but I still have no clue how to pricing american option.
Pricing a bond futures contract is already a very difficult task because of the embedded delivery option , not to mention an American option on it.
Here's a sketch of how you could go about doing it —.
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You may want to have time slices on at least the spot settlement date, some potential exercise dates, the last trade date of the futures, the first delivery date, and the last delivery date. The term structure model can be as simple as a short-rate model e. The model can be calibrated using either on-the-run bonds or cheapest-to-delivers.
In practice, however, many people diffuse bond yields directly Tuckman alluded to it in his book — starting from today's spot yields, you can use principal component factors to diffuse the yields into the future.
If you ignore the end-of-month option bond futures expire one week before the last delivery date and timing option bonds can be delivered any time between the first delivery date and the last delivery ate , you could assume that delivery happens on the last delivery date.
In this case, it's trivial to see which bond should be delivered on each node in a tree or path in a MC simulation the cheapest one. This allows you to compute the bond futures' price throughout the grid. These models can be super complex.
The delivery option part is particularly tricky and you should work closely with market makers with regard to the assumptions.
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For example, what volatility should you use to calibrate the model; do you want to model unauctioned bonds too; etc. Sign up for our newsletter and get our top new questions delivered to your inbox see an example. American Options are a tricky subject and pricing them is almost never easy. A lot depends on the model etc. Assuming you that you a familiar with monte carlo and that you know the risk neutral dynamics of your porcess - you could use monte carlo least squares.
Valuing American Options by Simulation: A Simple Least-Squares Approach. By posting your answer, you agree to the privacy policy and terms of service. By subscribing, you agree to the privacy policy and terms of service. Sign up or log in to customize your list. Stack Exchange Inbox Reputation and Badges.
Questions Tags Users Badges Unanswered. Quantitative Finance Stack Exchange is a question and answer site for finance professionals and academics. Join them; it only takes a minute: Here's how it works: Anybody can ask a question Anybody can answer The best answers are voted up and rise to the top. Pricing an american style option on a bond future. Probilitator 1, 7 Probilitator do you have any thought?
The price of an option is quoted by the market in real time, why would you need a pricing model? Helin Gai 4, 1 7 Did you find this question interesting? Try our newsletter Sign up for our newsletter and get our top new questions delivered to your inbox see an example.
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Please click the link in the confirmation email to activate your subscription. The paper on the topic is easily accesible and not too technical. I agree that pricing american option on equity is tricky. Sign up or log in StackExchange. Sign up using Facebook. Sign up using Email and Password.
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