Static Hedging of Standard Options

Peter Carr and Liuren Wu

Journal of Financial Econometrics, 2014, vol. 12, issue 1, 3-46

Abstract: Working in a single-factor Markovian setting, this article derives a new, static spanning relation between a given option and a continuum of shorter-term options written on the same asset. Compared to dynamic delta hedge, which breaks down in the presence of large random jumps, the static hedge works well under both continuous and discontinuous price dynamics. Simulation exercises show that under purely continuous price dynamics, discretized static hedges with as few as three to five options perform similarly to the dynamic delta hedge with the underlying futures and daily updating, but the static hedges strongly outperform the daily delta hedge when the underlying price process contains random jumps. A historical analysis using over 13 years of data on S&P 500 index options further validates the superior performance of the static hedging strategy in practical situations.

Keywords: Static hedging; jumps; option pricing; Monte Carlo; S&P 500 index options; stochastic volatility (search for similar items in EconPapers)
JEL-codes: C52 G12 G13 (search for similar items in EconPapers)
Date: 2014
References: View complete reference list from CitEc
Citations: View citations in EconPapers (18)

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Journal Article: Static Hedging of Standard Options (2013)
Working Paper: Static Hedging of Standard Options (2004)
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