Pricing American Options Time-Capped by a Drawdown Event

Zbigniew Palmowski and Pawe{\l} St\c{e}pniak

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Abstract: This paper presents a derivation of the explicit price for the perpetual American put option in the Black-Scholes model, time-capped by the first drawdown epoch beyond a predefined level. We demonstrate that the optimal exercise strategy involves executing the option when the asset price first falls below a specified threshold. The proof relies on martingale arguments and the fluctuation theory of L\'evy processes. To complement the theoretical findings, we provide numerical analysis.

Date: 2025-08
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