PRICING OPTIONS FROM THE POINT OF VIEW OF A TRADER

Sasha F. Stoikov ()
Additional contact information
Sasha F. Stoikov: Courant Institute of Mathematical Sciences, New York University, 251 Mercer Street, New York, NY 10012, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2006, vol. 09, issue 08, 1245-1266

Abstract: This paper is a contribution to the pricing and hedging of options in a market where the volatility is stochastic. The new concept of relative indifference pricing is further developed. This relative price is the price at which an option trader is indifferent to trade in an additional option, given that he is currently holding and dynamically hedging a portfolio of options. We find that the appropriate volatility risk premium depends on the trader's risk aversion coefficient and his portfolio position before selling or buying the additional option. We suggest two asymptotic expansions which relate the volatility risk premium to the Vega of the option portfolio. This approach provides a tool for traders to (i) integrate option pricing with risk management and (ii) quote competitive prices that depend on their aggregate risk exposure.

Keywords: Stochastic volatility; incomplete markets; relative indifference pricing; risk management; indifference hedge; Vega; Volga; Vanna (search for similar items in EconPapers)
Date: 2006
References: View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S0219024906004049
Access to full text is restricted to subscribers

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:ijtafx:v:09:y:2006:i:08:n:s0219024906004049

Ordering information: This journal article can be ordered from

DOI: 10.1142/S0219024906004049

Access Statistics for this article

International Journal of Theoretical and Applied Finance (IJTAF) is currently edited by L P Hughston

More articles in International Journal of Theoretical and Applied Finance (IJTAF) from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().