Portfolio Of Options Research Articles

Integer programs for margining option portfolios by option spreads with more than four legs

Margining is a crucial brokerage operation. In application to option portfolios it becomes exceptionally challenging because margin offsets with options require solving a highly intractable integer program. All these offsets are based on option spreads with a maximum of four legs. Although option spreads with more than four legs can be traced in regulatory literature of 2003, they have not yet been studied and used. Their usage in margin calculations would substantially increase the size of the program and therefore make it practically unsolvable. On the other hand, option spreads with more than four legs would allow the brokers to substantially increase the accuracy of margin calculations for option portfolios. In this paper we develop a theoretical framework for option spreads with any number of legs. We show that these spreads can be naturally described by homomorphisms of free abelian groups associated with option portfolios and option spreads with up to four legs. Using this observation we propose alternative integer programs that use option spreads with any number of legs and whose size does not depend on the number of legs. These programs can be solved in reasonable time and substantially increase the accuracy of margin calculations for option portfolios.

European basket option pricing by maximizing over a subset of lower bounds

In this paper we derive a lower bound for the price of a European basket option under the Black and Scholes framework. The bound is based on the conditioning method of [L.C.G. Rogers and Z. Shi, The value of an Asian option, J. of Appl. Prob. 32 (1995), 1077–1088] and [M. Curran, Valuing Asian and portfolio options by conditioning on the geometric mean, Management Science 40(12) (1994), 1705–1711]. We adapt the method of [K.W. Chen and Y.D. Lyuu, Accurate pricing formulas for Asian options, Applied Mathematics and Computation 188 (2007), 1711–1724] applied for Asian options to the case of the European basket options. Using an improved Monte Carlo method based on the antithetic variates, we benchmark our results. We also calculate the lower bound for various parameters involved, compare these results with those obtained by the improved Monte Carlo simulations and conclude that the proposed bound is indeed optimal.

On Arithmetic-Average Asian Power Options: Closed Forms and Explicit Methods for Valuation

The article considers arithmetic-averageAsian power options whose underlying follows geometric Brownian motion. Integral representations and consequent explicit methods for valuation are developed, with the former obtained by analytic inversion of a Laplace transform of Yor's. Principal methods for the replication of contingent claims on averages by Asian power options portfolios are derived. The results are numerically demonstrated in the case of Asian option valuation.

Macroeconomic Uncertainty and the Cross-Section of Option Returns

I empirically investigate whether macroeconomic uncertainty is a priced risk factor in the cross-section of equity and index option returns. The analysis employs a non-linear factor model, estimated with the Fama-MacBeth methodology, where the macroeconomic uncertainty factor is the return on a long/short portfolio of equity options, built on the basis of how implied volatilities change around scheduled macroeconomic announcements. I find that macroeconomic uncertainty is priced in the cross-section of option returns, even after controlling for a large set of relevant factors. The results are also robust to alternative ways of measuring option returns, and to the non-random pattern of missing returns.

Carbon sequestration via wood harvest and storage: An assessment of its harvest potential

A carbon sequestration strategy has recently been proposed in which a forest is actively managed, and a fraction of the wood is selectively harvested and stored to prevent decomposition. The forest serves as a ‘carbon scrubber’ or ‘carbon remover’ that provides continuous sequestration (negative emissions). Earlier estimates of the theoretical potential of wood harvest and storage (WHS) based on coarse wood production rates were 10 ± 5 GtC y−1. Starting from this physical limit, here we apply a number of practical constraints: (1) land not available due to agriculture; (2) forest set aside as protected areas, assuming 50 % in the tropics and 20 % in temperate and boreal forests; (3) forests difficult to access due to steep terrain; (4) wood use for other purposes such as timber and paper. This ‘top-down’ approach yields a WHS potential 2.8 GtC y−1. Alternatively, a ‘bottom-up’ approach, assuming more efficient wood use without increasing harvest, finds 0.1–0.5 GtC y−1 available for carbon sequestration. We suggest a range of 1–3 GtC y−1 carbon sequestration potential if major effort is made to expand managed forests and/or to increase harvest intensity. The implementation of such a scheme at our estimated lower value of 1 GtC y−1 would imply a doubling of the current world wood harvest rate. This can be achieved by harvesting wood at a moderate harvesting intensity of 1.2 tC ha−1 y−1, over a forest area of 8 Mkm2 (800 Mha). To achieve the higher value of 3 GtC y−1, forests need to be managed this way on half of the world’s forested land, or on a smaller area but with higher harvest intensity. We recommend WHS be considered part of the portfolio of climate mitigation and adaptation options that needs further research.

PORTFOLIOS OF AMERICAN OPTIONS UNDER GENERAL PREFERENCES: RESULTS AND COUNTEREXAMPLES

We consider the optimal exercise of a portfolio of American call options in an incomplete market. Options are written on a single underlying asset but may have different characteristics of strikes, maturities, and vesting dates. Our motivation is to model the decision faced by an employee who is granted options periodically on the stock of her company, and who is not permitted to trade this stock. The first part of our study considers the optimal exercise of single options. We prove results under minimal assumptions and give several counterexamples where these assumptions fail—describing the shape and nesting properties of the exercise regions. The second part of the study considers portfolios of options with differing characteristics. The main result is that options with comonotonic strike, maturity, and vesting date should be exercised in order of increasing strike. It is true under weak assumptions on preferences and requires no assumptions on prices. Potentially the exercise ordering result can significantly reduce the complexity of computations in a particular example. This is illustrated by solving the resulting dynamic programming problem in a constant absolute risk aversion utility indifference model.

Expected VIX Option Returns

We dissect the fine structure of volatility risks, as an important component of time-varying investment opportunities, by studying returns on VIX option portfolios. In particular, we provide model-free evidence regarding the two leading channels in modeling volatility risks: stochastic volatility-of-volatility and volatility jumps. We find that zero-delta straddles and delta-hedged portfolios of VIX options, which are neutral to changes in VIX but sensitive to volatility-of-volatility, underperform zero. In contrast, tail portfolios, which we construct by out-of-the-money and at-the-money VIX options and are only sensitive to tails risks of volatility, outperform zero. Therefore, risks in volatility-of-volatility and jump-induced volatility tails are priced, providing empirical support for both of the two leading channels. We further construct measures for volatility-of-volatility and volatility tail risks, by the whole set of out-of-the-money VIX options, to understand how they are priced relative to variance and equity risk premiums. We find that both measures predict short-horizon market returns, with the predictability from volatility-of-volatility risks subsumed by the variance premium but the volatility tail risk standing as a separate channel. Different from existing tail risk measures of merely market returns, our volatility tail index provides important information regarding how investors gauge the extreme volatility risks.

A review of climate geoengineering appraisals

AbstractDeliberate large‐scale interventions in the Earth's climate system—known collectively as ‘geoengineering’—have been proposed in order to moderate anthropogenic climate change. Amidst a backdrop of many ways of framing the supposed normative rationales for or against their use, geoengineering proposals are undergoing serious consideration. To support decision makers in the multitude of governance considerations a growing number of appraisals are being conducted to evaluate their pros and cons. Appraisals of geoengineering are critically reviewed here for the first time using a systematic literature search and screen strategy. Substantial variability between different appraisals' outputs originates from usually hidden framing effects relating to contextual and methodological choices. Geoengineering has largely been appraised in contextual isolation, ignoring the wider portfolio of options for tackling climate change—spanning mitigation and adaptation—and creating an artificial choice between geoengineering proposals. Most existing appraisal methods do not adequately respond to the post‐normal scientific context in which geoengineering resides and show a strong emphasis on closed and exclusive ‘expert‐analytic’ techniques. These and other framing effects invariably focus—or close down—upon particular sets of problem definition, values, assumptions, and courses of action. This produces a limited range of decision options which seem preferable given those framing effects that are privileged, and could ultimately contribute to the closing down of governance commitments. Emergent closure around particular geoengineering proposals is identified and argued to be premature given the need for more anticipatory, responsible, and reflexive forms of governing what is an ‘upstream’ domain of scientific and technological development.WIREs Clim Change2012, 3:597–615. doi: 10.1002/wcc.197This article is categorized under:Social Status of Climate Change Knowledge > Climate Science and Decision Making

The Evidence Base for Oxygen for Chronic Refractory Breathlessness: Issues, Gaps, and a Future Work Plan

Breathlessness or “shortness of breath,” medically termed dyspnea, is a common and distressing symptom featuring strongly in advanced lung, cardiac, and neuromuscular diseases; its prevalence and intensity increase as death approaches. However, despite the increasing understanding in the genesis of breathlessness, as well as an increasing portfolio of treatment options, breathlessness is still difficult to manage and engenders helplessness in caregivers and health care professionals and fear for patients. Although hypoxemia does not appear to be the dominant driver for breathlessness in advanced disease, the belief that oxygen is important for the relief of acute, chronic, and acute-on-chronic shortness of breath is firmly embedded in the minds of patients, caregivers, and health care professionals. This article presents current understanding of the use of oxygen for treating refractory breathlessness in advanced disease. The objective is to highlight what is still unknown, set a research agenda to resolve these questions, and highlight methodological issues for consideration in planned studies.

Decomposition valuation of complex real options embedded in creative financial leases

Creative financial leases offer more managerial flexibility for both the lessor and lessee. The flexibility can be valued as real options, but these options are exotic and complicated, and difficult to solve using traditional approach. We propose a decomposition and diagram method and the complex real options, expressed as a portfolio of vanilla options and simple exotic options. We discuss how the approach can be applied when valuing several typical creative financial leases, including a venture lease, percentage lease, lease with deferred payment, and cancelable lease. These results can be extended to other fields of real world investment. The decomposition and diagram method can help obtain analytic solutions, which facilitate the application of the real option approach and opens up a new method of real option valuation.

Managerial flexibility and the wealth effect of new product introductions

This paper examines whether investors recognize the value of managerial flexibilities, as proxied by real options, in their valuation of new product introductions. We define a firm’s real options portfolio as the difference between the firm’s market value and its assets in place. A firm’s strategic flexibilities are modeled as the ratio of its real option portfolio to its book value. Using a sample of new product introductions from 1998–2007, we find our real options measure is positively related to announcement period abnormal returns. This result holds after we control for other variables known to be correlated with the announcement effect in previous studies. Our result is robust to alternative measures of real options based on analysts’ earnings expectations and whether a firm has one or multiple segments. In summary, our results suggest that a firm’s perceived strategic and operating flexibilities are an important factor in the valuation of new products.

A Computational Approach to the Real Option Management of Network Contracts for Natural Gas Pipeline Transport Capacity

Commodity merchants use real option models to manage their operations. A central element of such a model is its underlying operating policy. We focus on network contracts for the transport capacity of natural gas pipelines, specific energy conversion assets. Practitioners commonly manage these contracts as portfolios of spread options. Although computationally fast, we show that this approach in general is heuristic because of the suboptimality of its operating policy. We propose a different computationally efficient real option approach based on an optimal operating policy, integrating linear optimization and Monte Carlo simulation. We use our approach to benchmark the spread option approach in a numerical study based on market data and realistic instances. We find that our approach can substantially improve on the contract valuations computed by the spread option approach, especially for contracts with flexibility in their allowed capacity usage. We also show that the optimal operating policy of contracts with this flexibility is of the greedy type, whereas the one of contracts without it in general is not. However, we observe that greedy optimization yields a near-optimal operating policy for the latter type of contracts with a substantially reduced computational effort. A version of our model was recently implemented by a major international energy trading company. Our model can also be employed to efficiently estimate the contract value sensitivities (the “Greeks”), which merchants use for financial hedging purposes. Potentially, our work has wider significance for the merchant management of other commodity conversion assets with payoffs determined by solving capacity constrained optimization models.

Product platform flexibility planning by hybrid real options analysis

Product platforms are believed to facilitate product design flexibility; however, the value and best form of such flexibility have yet to be fully understood. This article treats the design flexibility that is inherent in product platforms as being irreversible investment decisions that are crafted with a portfolio of platform real options that are continuously exercised to fulfill expected returns on investment. While options thinking has been appealing to the design community, the existing design real options models suffer from poor validity of the basic assumptions about the real options. Most existing work intuitively imitates real options decision making based on modularity and configuration. The missing link lies in the lack of an explicit time horizon, in which real options theory has its roots. This article proposes to craft platform real options in line with the management flexibility that is staged along the design project life. A hybrid real options analysis framework is developed by incorporating product-related and project-related flexibility to synthesize both financial and technical analyses of product platforms within a coherent framework. A case study of vibration motor platform planning demonstrates the potential of the proposed hybrid approach for the valuation of platform flexibility under uncertainty and for supporting optimal product platform planning.

Comparing carbon capture and storage (CCS) with concentrating solar power (CSP): Potentials, costs, risks, and barriers

Coal power coupled with Carbon [Dioxide] Capture and Storage (CCS), and Concentrating Solar Power (CSP) technologies are often included in the portfolio of climate change mitigation options intended to decarbonize electricity systems. Both of these technologies can provide baseload electricity, are in early stages of maturity, and have benefits, costs, and obstacles. We compare and contrast CCS applied to coal-fired power plants with CSP. At present, both technologies are more expensive than existing electricity-generating options, but costs should decrease with large-scale deployment, especially in the case of CSP. For CCS, technological challenges still remain, storage risks must be clarified, and regulatory and legal uncertainties remain. For CSP, current challenges include electricity transmission and business models for a rapid and extensive expansion of high-voltage transmission lines. The need for international cooperation may impede CSP expansion in Europe.

A Dynamic GAP Framework by Relaxing the Assumptions Behind the GAP and Duration GAP

This paper lists the assumptions behind the GAP and Duration GAP. These are related to parallel and synchronous changes in interest rates, changes in volume and composition of portfolio, early withdrawal and prepayment options, and convexity. The impact of the relaxation of these assumptions on the net interest income and economic value at risk are illustrated using examples. The movement to a dynamic GAP framework is facilitated by the discussion of assumption and impact of their relaxation.

The privilege and responsibility of having choices: decision-making for new vaccines in developing countries

Decisions to introduce new vaccines into national immunization programmes have become a highly complex endeavour. When the Expanded Programme on Immunization (EPI) was established in 1974 through a World Health Assembly resolution to build on the success of the global smallpox eradication programme and to ensure that all children in all countries benefit from life-saving vaccines, the first six diseases targeted by EPI were diphtheria, pertussis, tetanus, polio, measles and tuberculosis (WHO 1974). Today, thanks to scientific advancements and renewed global interest in immunization, more than a dozen antigens have been made available through public health services in developing countries, with increasingly reduced time delay compared with introduction in industrialized countries. Country decision-makers can select vaccines from a portfolio of options. This is a privilege and a serious responsibility requiring due consideration, as any decision to select one vaccine will need to be taken in light of the opportunity costs of not investing in another vaccine or another (health) intervention. Moreover, country decision-makers do not form their decisions in a vacuum; the number of immunization stakeholders in both the public and the private sectors has vastly increased and those stakeholders are equipped with varying levels of knowledge and expertise and may have vested interests. The multitude of factors influencing country decisions to introduce new vaccines, and the process for making these decisions is becoming increasingly important. These factors and processes are briefly outlined and discussed below.

Human power (HP) as a viable electricity portfolio option below 20 W/Capita

Human development and electrical energy co-exist seamlessly in high Human Development Index (HDI) countries11The United Nations Development Programme defines the human development index (HDI) with education, health, and economic indicators. “Co-exist seamlessly” means that it is almost assumed that a building will have access to electricity and that it is reliable. where reliability and availability of electricity is greater than 95%. In numerous low HDI countries,22Low HDI countries are defined with human development indexes at or below 0.50. there is 5–50% electric grid availability. These electric grids can have reliability below 50% due to faults and extreme load shedding. Unavailable and unreliable electric grid events are situations disconnected from a centralized grid (if the grid fails then it is off-line). In Africa, renewable energy portfolios include solar, wind, biomass, biogas, small hydroelectric power and recently nuclear energy (MEMD, 2005, 2006, 2008, 2009) and are cited to meet the disconnected grid situations. However, Human Power (HP) is a missing portfolio option and, if implemented in countries with average electrical power consumed below 20W/Capita, would impact human development directly. The technologies include merry-go-round generators in schools, hand crank lighting in hospitals and health clinics during electricity outages and bicycle generators for off-grid businesses. This result is derived from (1) a new energy concept defined as PACE (People-based Activities Caloric Energy), (2) estimations from children's play — energy harvesting as free energy (3) disconnected-grid fuel costs for petrol and diesel generators, and (4) policy empowerment which is based on designing and building microgrids. These designs result from an innovative Physics and Business of Energy (PBE) curriculum, in conjunction with University of Michigan (USA), taught in Uganda at Mountains of the Moon University, Makerere University and St. Joseph's Technical Institute with an association called Uganda Small Scale Industries Association (USSIA). The HP-module is part of a multi-module curriculum for Empowering Ugandans to Power Uganda. The overall educational and design policies create a key missing gateway to co-designed and locally built microgrids. These policies are applicable in many, if not all, low HDI countries.

Equity Risk Incentives and Corporate Tax Aggressiveness

ABSTRACT This study examines equity risk incentives as one determinant of corporate tax aggressiveness. Prior research finds that equity risk incentives motivate managers to make risky investment and financing decisions, since risky activities increase stock return volatility and the value of stock option portfolios. Aggressive tax strategies involve significant uncertainty and can impose costs on both firms and managers. As a result, managers must be incentivized to engage in risky tax avoidance that is expected to generate net benefits for the firm and its shareholders. We predict that equity risk incentives motivate managers to undertake risky tax strategies. Consistent with this prediction, we find that larger equity risk incentives are associated with greater tax risk and the magnitude of this effect is economically significant. Our results are robust across four measures of tax risk, but do not vary across several proxies for strength of corporate governance. We conclude that equity risk incentives are a significant determinant of corporate tax aggressiveness.

AN EXPLICIT OPTION-BASED STRATEGY THAT OUTPERFORMS DOLLAR COST AVERAGING

Dollar cost averaging (DCA) is a widely employed investment strategy in financial markets. At the same time it is also well documented that such gradual policy is sub-optimal from the point of view of risk averse decision makers with a fixed investment horizon T > 0. However, an explicit strategy that would be preferred by all risk averse decision makers did not yet appear in the literature. In this paper, we give a novel proof for the suboptimality of DCA when (log) returns are governed by Lévy processes and we construct a dominating strategy explicitly. The optimal strategy we propose is static and consists in purchasing a suitable portfolio of path-independent options. Next, we discuss a market governed by a Brownian motion in more detail. We show that the dominating strategy amounts to setting up a portfolio of power options. We provide evidence that the relative performance of DCA becomes worse in volatile markets, but also give some motivation to support its use. We also analyse DCA in presence of a minimal guarantee, explore the continuous setting and discuss the (non) uniqueness of the dominating strategy.

Combined Pricing and Portfolio Option Procurement

In this paper, we study a single‐product periodic‐review inventory system that faces random and price‐dependent demand. The firm can purchase the product either from option contracts or from the spot market. Different option contracts are offered by a set of suppliers with a two‐part fee structure: a unit reservation cost and a unit exercising cost. The spot market price is random and its realization may affect the subsequent option contract prices. The firm decides the reservation quantity from each supplier and the product selling price at the beginning of each period and the number of options to exercise (inventory replenishment) at the end of the period to maximize the total expected profit over its planning horizon. We show that the optimal inventory replenishment policy is order‐up‐to type with a sequence of decreasing thresholds. We also investigate the optimal option‐reservation policy and the optimal pricing strategy. The optimal reservation quantities and selling price are shown to be both decreasing in the starting inventory level when demand function is additive. Building upon the analytical results, we conduct a numerical study to unveil additional managerial insights. Among other things, we quantify the values of the option contracts and dynamic pricing to the firm and show that they are more significant when the market demand becomes more volatile.