Pricing Spread Options by the Operator Splitting Method

Abstract

Based upon the Strang operator splitting method, we have presented a simple approach to improve Kirk's approximation for spread options in a straightforward manner. Illustrative numerical examples have demonstrated that our proposed approximation scheme is able to provide very accurate estimates of the option prices without compromising the efficiency of Kirk's approximation. As the approximate option prices are given in closed form, analytical formulae for the Greeks can be derived explicitly. Moreover, since the proposed approach is simple and straightforward, we believe that it can be easily applied to the multi-asset spread options as well.