Abstract
A spread option involves the right to obtain the spread between two asset prices at a predefined strike price. This type of derivative security is frequently used in financial markets and academic finance. Furthermore, analysts use the spread option technique for real option modeling purposes. Some spread options are American-type in the sense that an option holder may exercise her option prior to the expiration. In this paper, we propose an equivalence condition for American spread options under which they are not exercised early, and are therefore equivalent to European options. Our theoretical results, developed within a model-free economic setting, suggest that the equivalence conditions documented by previous papers do not hold in a distribution-free environment. Traders, quantitative modelers, and financial programmers in various derivatives markets and the real option modeling area may use our results.
Highlights
In financial markets, a derivative security refers to a contract whose value depends on the values of other assets
A spread option involves the right to obtain the spread between two asset prices at a predefined strike price
We study an equivalent condition of American spread options in a model-free economic setting
Summary
A derivative security refers to a contract whose value depends on the values of other assets (underlying assets). One of the simplest examples is a call option that gives the right but not the obligation to buy an underlying asset at a strike price. A call option value depends on only one underlying asset price, but other derivative securities, e.g., exchange and spread options, have two underlying assets. A spread option involves the right to obtain the spread between two asset prices at a predefined strike price ([1]). An exchange option is a special case of a spread option where the strike price is set to zero.
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