Option valuations and asset demands and supplies

Jin-Ray Lu and Ya-Huei Yang

The Quarterly Review of Economics and Finance, 2021, vol. 80, issue C, 49-64

Abstract: If stock demand and supply determine stock prices, it should be possible for them to change option premiums. We propose a new valuation formula for pricing European options on the underlying stock, the price of which is determined by its demand and supply in a given transaction. Our mathematical model and numerical evidence demonstrate that the premiums of call options are increased with the stock demand and decreased with stock supply, and that the premiums of put options move downward with the stock demand and move upward with stock supply. Rather than by a given exogenous process that describes stock prices in option pricing models, we generate the stock price process by looking at the asset’s supply and demand. This notion regarding an underlying asset’s price determination can be further applied to develop other option valuation models.

Keywords: Stock demand; Stock supply; Underlying asset; Exogenously given process (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:quaeco:v:80:y:2021:i:c:p:49-64

DOI: 10.1016/j.qref.2021.01.011

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