Option Holder Research Articles

Super-replication of life-contingent options under the Black–Scholes framework

Abstract We consider the super-replication problem for a class of exotic options known as life-contingent options within the framework of the Black–Scholes market model. The option is allowed to be exercised if the death of the option holder occurs before the expiry date, otherwise there is a compensation payoff at the expiry date. We show that there exists a minimal super-replication portfolio and determine the associated initial investment. We then give a characterisation of when replication of the option is possible. Finally, we give an example of an explicit super-replicating hedge for a simple life-contingent option.

Practical Applications of Information Content of Hedge Fund Equity Option Holdings

Practical Applications of Information Content of Hedge Fund Equity Option Holdings

The Information in Hedge Fund Option Holdings

We provide new insights on how hedge funds use options and short-selling channels to trade on their negative information. Bearish information in hedge fund option positions is economically large, distinct from information in short interest, and it is the combination of option positions and short interest that provides the strongest information signal. A portfolio of stocks with high short interest and bearish hedge fund option positions predicts negative abnormal returns that are more than four times as large as the portfolio with high short interest and bullish options positions. The information in hedge fund option positions increases during periods of market stress, whereas that in short interest does not. This increase is concentrated in capital-constrained hedge funds, suggesting that options provide a channel for capital-constrained hedge funds to exploit their information advantage. This paper was accepted by Lukas Schmid, finance. Funding: J. Hua received support for this project from a PSC-CUNY Award, jointly funded by The Professional Staff Congress and The City University of New York. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2023.4785 .

Exchange liquidity and redemption liquidity

Abstract Disagreements over the nature of money and consequent confusions regarding liquidity contribute to difficulties integrating monetary theory into the theory of value. For example, an abundance of market liquidity is assumed in asset pricing, whereas a scarcity of monetary liquidity is deemed necessary for consumer price-level determinacy. This paper builds on the insights gained from the evolution of finance to introduce a distinction between exchange liquidity and redemption liquidity as a means of resolving this conceptual dissonance. Both exchange and redemption liquidity can be conceptualised as types of financial option differing in the exercise mechanism offered to the option holder by the option-writer.

American strangle options with arbitrary strikes

AbstractThe so‐called American strangle options are examined in this paper. Their main characteristic is the combined put and call feature. The holder has the right to exercise prematurely choosing the option's style—put or call. We abandon the traditional assumption that the put strike is below the call one considering arbitrary values. We also assume that the put and call weights are different. The equations for the early exercise boundaries are derived in the perpetual case. After that we approximate numerically these boundaries for the finite maturity options maximizing the option holder's utility. On the basis of them we apply a Crank–Nicolson finite difference method to the corresponding Black–Scholes‐style partial differential equation to obtain the fair option price.

Valuing options to renew at future market value: the case of commercial property leases

In this study, we develop and empirically test a valuation model for a commonly encountered option in office leases: a tenant’s option to renew at future market rent (a fair market value) with lease termination as the maturity date. The model integrates decision analysis with real options analysis and market risk with private risks. “Option value” is defined as the private value of the option to either party pre-contract, while “option price” assumes a fair agreement between transacting parties and can be positive (rental premium paid) or negative (rental discount offered). Without manifest expectations, an analysis of a sample of office leases supports the model’s logic with price estimates in a practical range. The tenants’ option price/value is shown to have a negative relationship with the original/renewal lease term; conversely, the landlords’ option value is positively related to the original/renewal term. Comparative analyses show that transaction costs have a positive effect on tenants’ option value and on prices, while vacancy costs and the vacancy period are both positively related to the landlords’ option value and negatively related to price. Market rent is found to have a negative relationship with option price. Overall, this study provides a theoretical analysis and empirical tests of the value of a real option that allows option holders to renew/extend their contracts at a fair market value.

Information Content of Hedge Fund Equity Option Holdings

Using a novel sample of 13F reports, the authors document that hedge funds prefer to purchase equity options whose characteristics are particularly well-suited for informed trading. They show that hedge funds purchase liquid high-embedded leverage options without lottery-like skewness. Consistent with informed trading, they find that directional options held by hedge funds deliver superior returns. Although 13F holdings are reported with a 45-day lag, the authors demonstrate that investors can earn profits by utilizing publicly available information on hedge funds’ option holdings. They confirm that hedge funds’ options add value to the total portfolios, indicating that options are economically significant.

PENENTUAN HARGA OPSI DENGAN MODEL REGIME SWITCHING LOGNORMAL (RSLN) 2-STATE

An option is a contract between two parties in which the option holder has the right to buy or sell a certain amount of instrument at a certain price within a predetermined period of time. The purpose of this study was to determine the price of buy and sell european type options using the regime switching lognormal 2-state model. The parameters of the regime switching lognormal 2-state model are estimated using the EM Algorithm. This study used secondary data on stock prices with parameter estimation results showing a standard deviation in state-1 of 0.025543 with an average of 0.006355 and a standard deviation in state-2 of 0.051013 with an average of -0.005482. The estimated results obtained the price of european type selling and buying options of 98.40 and 1033.48 respectively for the execution price of 4000.

Employee behavior in employee stock option plans: Why do some employees acquire company stock?

AbstractThe article focuses on decisions to exercise and hold company stock at the maturity of a broad‐based employee stock options plan. It investigates why some participants choose an uncertain and risky future reward when an immediate and certain increase in wealth could be secured at exercise. It draws on and expands the “mixed gambles” perspective in behavioral agency theory, utilizing a combination of stock price data and employee survey data from British companies with tax‐approved stock option plans. It is found that the decision to take a gamble is influenced (negatively) by the extent of stock price lows (relative to prices at exercise) in the year prior to exercise, and by the risk preferences of the option holder. The findings contribute to further development of the “mixed gambles” perspective as an explanation of stock option behavior, showing that individual characteristics as well as some stock price movements affect behavior.

Investment horizon and option market activity

AbstractThis paper uses a unique data set of institutional investors’ equity and equity option holdings to investigate how their investment horizons are associated with option trading and its information content. Firms with more short‐term investors have more active option markets relative to stock markets. Also, they have a greater proportion of option trading volume ascribed to high‐leveraged contracts. Furthermore, both abnormal option trading before earnings announcements and informativeness of option market statistics are more pronounced when short‐term investors predominate. These findings suggest that short‐term institutions trade leveraged contracts actively to exploit information, thus effecting price discovery in option markets.

HEDGING OF AMERICAN OPTIONS IN ILLIQUID MARKETS WITH PRICE IMPACTS

We consider a setup in which a large trader has sold a number of American-style derivatives and can have an impact on prices by trading the underlying asset for hedging purposes. The price impacts are assumed to be temporary and decay exponentially with time. Due to the impact of trading on prices, the large trader may also be tempted to minimize the payoff of the derivative by manipulating the underlying asset. Since the option holders have the right to exercise the option at any time before expiry, we consider a robust optimization problem for the large trader, in which the underlying uncertainty is the exercise time. It is shown that the solution of this optimization problem can be described as the solution of a double obstacle variational inequality. The optimal strategy for the large trader and the worst-case exercise time for the option holder are obtained explicitly in terms of the value function. We conclude with a sensitivity analysis in which we compare the timing and size of trades by the large trader as well as the exercise region for the options holders for different levels of liquidity, and identify situations that may lead to potential price manipulation.

Stock derivatives and seasoned equity offerings

PurposeThe article aims to explore if stock derivative types (stock options and stock warrants) are associated with stock returns for firms undergoing seasoned equity offerings (SEOs).Design/methodology/approachThe authors regress stock returns against stock derivatives for periods around SEO announcements with standard errors clustered at the month level.FindingsThe authors find that lower stock derivatives holdings for the fiscal year after the SEO are associated with superior pre-SEO returns. This can be explained by owners exercising their derivatives to capitalize on the pre-SEO price run-up. The authors find that greater stock option holdings by insiders for the fiscal year after the SEO are associated with superior post-SEO returns for up to ten years after the SEO announcement. This new finding does not hold for stock warrants.Research limitations/implicationsStock derivatives are supplied by Capital IQ. Given their description, the authors infer that stock options are owned largely by insiders. Thus, the insider conclusions for stock options depend on this implication.Practical implicationsStock options and stock warrants can be used strategically to reward stock derivative owners of strong performing firms for past performance. Stock options can be used to motivate insiders (primarily key executives) to achieve superior future performance.Originality/valueThis study is unique in comparing the influence of holdings for stock options and stock warrants on stock price performance around SEOs. The authors show that the sign of the association depends on whether the test includes pre-SEO periods.

Proactive Hedging European Option Pricing with a General Logarithmic Position Strategy

This study proposes an exotic option that extends the classical European option by requiring option holders to continuously trade in underlying assets according to a predesignated trading strategy with a general logarithmic position. The pricing formula for the exotic option with a general logarithmic strategy is derived from the Black–Scholes option pricing formula, and its price advantage is compared (based on simulations) to the classical European option and to the exotic option with a linear position. By varying key parameters, we found that the exotic option with a general logarithmic position has a significant price advantage (up to 34% under certain parameter settings) over the classical European option. Moreover, the exotic option with a general logarithmic strategy can save 5.5% more of the option premium than applying a linear position strategy. Our simulation results indicate that the price advantage of this proactive hedging option with a general logarithmic strategy depends heavily on the initial amount of capital; in particular, this exotic option is more suitable for traders with limited initial amounts of capital.

Exchange options for catastrophe risk management

In this paper, we investigate the pricing issue and catastrophe risk management of exchange options. Exchange options allow the holder to exchange its stocks for another at maturity and can be seen as an extended version of catastrophe equity put options with another traded asset price as strike prices. Since option holders have to issue new shares to exercise the option, we illustrate the differences between option prices calculated using pre-exercise and post-exercise share prices. The effects of default risk on option prices and risk management are also considered. Finally, risk management analysis shows that exchange options can effectively hedge catastrophe risk.

Audit committee ownership and the cost of equity capital

PurposeThis paper aims to investigate whether audit committee ownership (consisting of both equity holdings and option holdings) is associated with the cost of equity capital.Design/methodology/approachThis paper uses regression analysis to examine the association between audit committee ownership and the cost of equity capital. The data set consists of 2,825 firm-year observations for companies listed on the ASX between 2001 and 2015. This paper also conducts tests to explore the mediating effects of financial reporting quality, firm performance and the risk of reporting problems, on the relation between audit committee ownership and cost of equity capital.FindingsThe analyses reveal that audit committee ownership reduces the firm’s cost of equity and, thereby, support the incentive alignment view. However, the association is driven primarily by audit committee equity ownership, with option holdings having an insignificant effect. This paper also finds that firm performance mediates the association between audit committee ownership and the cost of equity capital.Practical implicationsFindings of the existing corporate governance research relating to the cost of equity capital and audit committee ownership remain sparse in the context of “comply-or-explain” types of regulatory environment, like that of Australia. The findings indicate that principle-based discretionary governance arrangements, e.g. compensating audit committee members with company equity, may bring benefits to firms in terms of cheaper financing. Regulators, scholars and practitioners are invited to consider further the comprehensive implications of the structure and transparency of audit committee incentives on the effective functioning of security markets.Originality/valueThe effects of audit committee ownership on the cost of equity capital are an issue of direct economic consequence for equity investors. The main finding of this study, namely, that a firm with higher audit committee share ownership is likely to benefit from a lower cost of equity capital, therefore adds value to the limited extant literature.

CONSUMPTION AND INVESTMENT VALUES IN HOUSING PRICE: A REAL OPTIONS APPROACH

Homeowners can be viewed as the put option holders who can sell housing to lenders when the housing price is lower than its mortgage value and sell houses when the housing price rises above a certain threshold. On the basis of the theory of investment under uncertainty, we model the housing value from the perspective of houseowners who can choose to either live in their houses or switch houses for comfort improvement and price appreciation. We can decompose the housing value into consumption and investment values by exploring parameters affecting housing value and decision making of houseowners. We find that the proportion of investment value to housing value increases with the volatility of the housing market, indicating the possible formation of housing bubbles. In addition, the comfort and utility provided by housing are critical for homeowners to decide whether to sell their houses. The analysis provides policymakers and market participants in the real estate market with insights into the price formation of real estate.

Managerial Sentiment and Employment

We study firms' hiring decisions in a world in which both managers and investors are prone to expectation errors. We show that high managerial sentiment increases employment growth, especially at firms with worse investment opportunities and low-quality corporate governance, and during times of low investor sentiment. Using data on U.S. publicly traded companies and CEO option holdings, we find evidence consistent with these predictions. The results unveil a new channel through which managerial sentiment affects firms' operations, and suggest that managerial optimism can counter the negative effect of pessimistic investors on labor markets.

Mutual Fund Hedging Demands and the Cross-Section of Variance Risk Premiums

This paper empirically studies whether institutional stock holdings predict equity option returns. I find that institutional concentration in the underlying stock negatively predicts the cross-section of corresponding option returns. Evidence is consistent with a hedging and demand pressure channel: For stocks with more concentrated ownership, some institutional holders are more likely to overweight them and demand more of their options to hedge. To absorb the order imbalances, dealers sell options and charge higher prices, leading to lower option returns. Using option holdings of U.S. equity mutual funds, I document a positive correlation between funds' stock concentration and their option share in the same firms.

Local Activator and T Cell Engager (αBCMA x αPD-L1 x αCD3) with Enhanced Tumor Killing and Minimal Cytokine Release for the Treatment of Multiple Myeloma

BCMA-targeting bispecific T-cell engagers in clinical development have demonstrated encouraging preclinical efficacy. The most advanced of these is AMG 420, which showed significantly improved response rates in relapsed/refractory multiple myeloma (MM) patients. Nevertheless, median duration until relapse is currently limited to approximately 12 months, highlighting the need for new drugs with novel MoA. Recently, we reported on a Local Activator and T cell Engager (LocATE) antibody that targets BCMA and selectively blocks programmed death-ligand 1 (PD-L1) on malignant cells (ASCO, June 2019). LocATE induced superior T cell activation and cancer cell killing, in vitro and ex vivo, compared to a BCMAxCD3 BiTE alone or in combination with a PD-L1 inhibitor. Here, we sought to further characterize the novel MoA of our LocATE. To assess the therapeutic potential of the LocATE, we first investigated whether potent cytotoxicity is uncoupled from high levels of cytokine release. We evaluated three LocATE molecules with different PD-L1 affinities (low, medium, high). Using BCMA-expressing MM cell lines (U-266, MM.1S, RPMI-8226 and H929) with distinct PD-L1 surface expression levels (3 - 53%), we determined the cytokine profile (IL-2, IL-6, IFN-γ, TNF-α) and target cell lysis induced by each candidate in the presence of CD3-positive human T cells. All three candidates exhibited comparable killing potency, however, low-affinity PD-L1 LocATE antibodies induced significantly less cytokine release (up to 10-fold) than its higher PD-L1 affinity counterparts across all cell lines investigated. Notably, using the low-affinity PD-L1 LocATE, we observed a 2-fold increase in tumor cell killing compared to bispecific BCMAxCD3 targeting controls in cell lines expressing high PD-L1 levels (53%), underlining the contribution of PD-L1 inhibition. Accordingly, phenotypic profiling of effector cells showed that the LocATE more potently induced dose-dependent upregulation of the activation markers CD69, CD25 and HLA-DR compared to bispecific controls. Importantly, cytotoxic activity, T cell activation and cytokine release were not induced when BCMA-negative cells expressing high levels of PD-L1 were treated with LocATE, underlining the BCMA-selective killing mechanism. Since the superior efficacy of LocATE was found to correlate with the expression level of PD-L1 on MM cell lines and upregulation of PD-L1/PD-1 has been reported as one of the major myeloma cell escape mechanisms during treatment with BiTEs, we subsequently investigated the efficacy of LocATE using primary bone marrow samples and peripheral blood mononuclear cell (PBMCs) obtained from MM patients. Six bone marrow mononuclear cell (BMMC) and eight PBMC samples from MM donors of different disease stages were characterized for PD-1/PD-L1 expression levels; analysis of T cell frequency and level of activation/exhaustion was performed based on CD4, CD8, CD25, CD69, Tim-3, Lag-3 and PD-1 marker expression. Using patient samples with high frequencies of PD-1 expressing T cells prior to treatment, LocATE induced superior MM tumor cell lysis and T cell activation compared to BCMAxCD3 bispecific antibodies. No activity was observed on healthy cells, underlining the safe and selective killing mechanism through tumor-local reactivation of exhausted T cells. Collectively, these findings demonstrate that the simultaneous T cell redirection and tumor-specific checkpoint inhibition with the LocATE leads to an improved therapeutic index with robust tumor cell killing and low levels of cytokine release. Capable of counteracting adaptive immune resistance caused by increased PD-1/PD-L1 signaling, the LocATE antibody has the prospect to significantly improve survival for multiple myeloma patients. Disclosures Vrohlings: CDR-Life: Current Employment. Jungmichel:CDR-Life: Current Employment, Other: current option holder. Senn:CDR-Life: Current Employment. Schleier:CDR-Life: Current Employment, Current equity holder in private company. Scheifele:CDR-Life: Current Employment, Current equity holder in private company. Wendelspiess:CDR-Life: Current Employment. Leisner:CDR-Life: Current Employment, Current equity holder in private company, Membership on an entity's Board of Directors or advisory committees. Jaeger:CDR Life AG: Consultancy, Research Funding; Miltenyi: Consultancy, Honoraria; Karyopharm: Honoraria; BMS/Celgene: Consultancy, Honoraria, Research Funding; Gilead: Honoraria, Research Funding; Novartis: Consultancy, Honoraria, Research Funding; AbbVie: Honoraria; F. Hoffmann-La Roche: Honoraria, Research Funding. Borras:CDR-Life: Current Employment, Current equity holder in private company.

Levered and inverse VIX ETP option contract adjustments: No harm, no foul?

AbstractThe terms of exchange‐traded stock option contracts are usually adjusted when corporate actions take place. These adjustments are made to safeguard the value of the outstanding option contracts. Recently, a new type of corporate event has appeared − levered and inverse exchange‐traded product issuers are reducing leverage ratios with increased frequency. While such changes directly affect option values, no contract adjustments are made, resulting in windfall transfers of wealth from outstanding long to outstanding short option holders. In one instance alone, the transfer was more than $US100 million. To remedy the problem, we offer a simple contract adjustment procedure.