An Option Pricing Formula for Active Hedging Under Logarithmic Investment Strategy

Minting Zhu, Mancang Wang and Jingyu Wu ()
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Minting Zhu: School of Economics and Management, Northwest University, Xi’an 710127, China
Mancang Wang: School of Economics and Management, Northwest University, Xi’an 710127, China
Jingyu Wu: School of Economics and Management, Northwest University, Xi’an 710127, China

Mathematics, 2024, vol. 12, issue 23, 1-20

Abstract: Classic options can no longer meet the diversified needs of investors; thus, it is of great significance to construct and price new options for enriching the financial market. This paper proposes a new option pricing model that integrates the logarithmic investment strategy with the classic Black–Scholes theory. Specifically, this paper focus on put options, introducing a threshold-based strategy whereby investors sell stocks when prices fall to a certain value. This approach mitigates losses from adverse price movements, enhancing risk management capabilities. After deriving an analytical solution, we utilized mathematical software to visualize the factors influencing new option prices in three-dimensional space. The findings suggest that the pricing of these new options is influenced not only by standard factors such as the underlying asset price, volatility, risk-free rate of interest, and time to expiration, but also by investment strategy parameters such as the investment strategy index, investment sensitivity, and holding ratios. Most importantly, the pricing of new put options is generally lower than that of classic options, with numerical simulations demonstrating that under optimal parameters the new options can achieve similar hedging effectiveness at approximately three-quarters the cost of standard options. These findings highlight the potential of logarithmic investment strategies as effective tools for risk management in volatile markets. To validate our theoretical model, numerical simulations using data from Shanghai 50 ETF options were used to confirm its accuracy, aligning well with theoretical predictions. The new option model proposed in this paper contributes to enhancing the efficiency of resource allocation in capital markets at a macro level, while at a micro level, it helps investors to apply investment strategies more flexibly and reduce decision-making errors.

Keywords: put option; Black–Scholes option pricing model; logarithmic investment strategy; risk management; numerical simulations (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2024
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