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We examine an option contract from a supplier’s perspective and apply mean-variance method to analyze the supplier’s risk. Compared with the newsvendor model without an option contract, we theoretically prove that the option contract can also benefit the supplier. We find for a given option exercise price, there exists an option price such that the contract with the option price dominates those with smaller option price in terms of mean variance of the supplier’s profit. Computational studies have also been conducted in the paper.

This paper examines mispricing, volatility and parity on the Hang Seng Index (HSI) options and futures market. Most of the previous research has focused on futures contracts; we update this research and extend it by considering also option contracts. It is also important to examine these issues post 1997 Asian crisis. We find mispricing of HSI futures and option contracts if no transaction costs were considered. However, by incorporating transaction costs, the HSI futures are bounded within the arbitrage free region and most of the mispricing of the HSI options disappears. Additional tests on the mispricing series reveals that most of the derivative HSI contracts are positively autocorrelated and that the mispricing series for both derivative contracts are not identical among the different contract months. From our results we cannot conclude that there is causal relationship between the mispricing and the spot index volatility. Finally, our empirical results show that for HSI derivative contracts future and option parity holds, supporting our mispricing test that the HSI derivative market is efficient and has not been adversely affected by the Asian economic crisis.

This paper examines the dynamics of returns and order imbalances across the KOSPI 200 cash, futures and option markets. The information effect is more dominant than the liquidity effect in these markets. In addition, returns have more predictability power for the future movements of prices than order imbalances. Information seems to be transmitted more strongly from derivative markets to their underlying asset markets than from the underlying asset markets to their derivative markets. Finally, domestic institutional investors prefer futures, domestic individual investors prefer options, and foreign investors prefer stocks relative to other investor groups when they have new information.

We assume that the call option's value is correctly priced by Black and Scholes' option pricing model in this paper. This paper derives an exact closed-form solution for implied standard deviation under the condition that the underlying asset price equals the present value of the exercise price. The exact closed-form solution provides the true implied standard deviation and has no estimate error. This paper also develops three alternative formulas to estimate the implied standard deviation if this condition is violated. Application of the Taylor expansion on a single call option value derives the first formula. The accuracy of this formula depends on the deviation between the underlying asset price and the present value of the exercise price. Use of the Taylor formula on two call option prices with different exercise prices is used to develop the second formula, which can be used even though the underlying asset price deviates significantly from the present value of the exercise price. Extension of the second formula's approach to third options value derives the third formula. A merit of the third formula is to circumvent a required parameter used in the second formula. Simulations demonstrate that the implied standard deviations calculated by the second and third formulas provide accurate estimates of the true implied standard deviations.

There are two ad hoc approaches to Black and Scholes model. The “relative smile” approach treats the implied volatility skew as a fixed function of moneyness, whereas the “absolute smile” approach treats it as a function of the strike price. Previous studies reveal that the “absolute smile” approach is superior to the “relative smile” approach as well as to other sophisticated models for pricing options. We find that the time-to-maturity factors improve the pricing and hedging performance of the ad hoc procedures and the superiority of the “absolute smile” approach still holds even after the time-to-maturity is considered.

Roadmapping provides a visual canvas upon which a depiction of business strategy can be articulated and shared both within and between organizations. In this regard, roadmaps can be considered as boundary objects because they are used to forge the links between the differing stakeholders and communicate their shared viewpoints. Typically, the format of the roadmap is that of a skeletal structure consisting of a time-based axis against layers of functional perspectives (e.g., market, product, technology). However, in the later stages of the strategic planning and development activity, there is a need to clearly represent the options identified and embed the associated quantitative measures in the roadmap so as to provide greater assistance in the decision-making process. This is critical since options embody flexibility. From a program management perspective such flexibility is typically manifested through making decisions as to whether to defer, abandon, switch, expand/contract different project elements; for instance, choosing to terminate specific R&D, design or procurement activities. Such decisions are made upon evolving market, product and technology conditions. For example, customer needs, operational requirements, product functionalities and performance levels, technology availability and maturity. In order to visually represent options in terms of decision-point timing and size of investment, this paper presents an initial set of visual objects that could be overlaid on the canvas of a roadmap. To illustrate their use, a real-world case study is presented. A fully populated options-based roadmap, containing a set of alternative futures, is described. It is intended that this roadmap acts as a graphical prototype form for visually depicting options and associated investment appraisal information.

We employ neural networks to understand volatility surface movements. We first use daily data on options on the S&P 500 index to derive a relationship between the expected change in implied volatility and three variables: the return on the index, the moneyness of the option, and the remaining life of the option. This model provides an improvement of 10.72% compared with a simpler analytic model. We then enhance the model with an additional feature: the level of the VIX index prior to the change being observed. This produces a further improvement of 62.12% and shows that the expected response of the volatility surface to movements in the index is quite different in high and low volatility environments.

Previous studies of the limit order book report that low depths accompany wide spreads and that spreads widen and depths fall in response to higher volume, but some postulate a positive relationship between spreads and depth during normal trading periods. We calculate the option value of the limit order book at 11:00 a.m. for 10 actively traded firms listed on the Australian Stock Exchange. Simultaneously this approach enables us to consider the spread and depth of the limit order book. We find that 33.1% of the option value of the limit order book is provided at the best ask and 34.7% at the best bid. We find that the option value of the limit order book is greatest at the best bid price and the best ask price and is more stable through time than the option value of individual shares or share quantities in the book. Also, consistent with the arguments of Cohen et al. (1981), we find evidence of equilibrium in the supply and demand of liquidity.

This paper investigates the significance of using a variable default boundary when pricing European Black-Scholes options that are subjected to credit risks. We apply numerical method and combine Klein [1] and Johnson and Stulz [2] to link the payout ratio proportionally to the assets of the option writer. We also link the payout ratio to the value of the assets of the writer. Numerical examples compare our results with Klein [1] and Johnson and Stulz [2] based on alternative assumptions, and illustrate when the application of variable default boundary becomes important.

This chapter proposes a theoretical model of initial public offering by taking into account the uncertainty in security pricing and the underwriting process. Three major factors are shown to affect the IPO pricing: (1) the uncertainty of stock price, (2) the legal requirement that restricts underwriters from selling any part of the issue above the fixed offering price, and (3) the underwriters' risk tolerance. It is shown that underpricing is negatively related to the underwriter's risk tolerance, and positively related to the length of premarket period and market price volatility.