The Bachelier Model: Option Pricing with Negative Strike and Asset Price

You Zhang and Lingtong (Stanley) Meng

Chapter 11 in The CME Vulnerability:The Impact of Negative Oil Futures Trading, 2020, pp 215-222 from World Scientific Publishing Co. Pte. Ltd.

Abstract: On April 20, for the first time in history, a major oil future, West Texas Intermediate (WTI) May contract, closed below zero, raising alerts among market participants and regulators on the real possibility of negative prices, which is not a standard assumption when pricing derivatives outside the fixed income market. Following the event, the Chicago Mercantile Exchange (CME) announced that the Bachelier model would be used instead of the standard Black–Scholes model accounting for pricing negative strike options. In this paper, we first compare the two models and highlight their key technical differences; then we present the potential implications caused by model switching on derivatives pricing, risk management, and market structure from a practitioner’s point of view; lastly, we discuss some practical points the regulator should be noting when considering to modify the current regulatory framework.

Keywords: CME; Vulnerability; WTI; Oil; Trading; Rule; 420; Negative Trading Price; Best Practice; Valuation; Risk Management; Regulatory; Rule; Accounting; Standard; Fair Value; Trading Behaviour; Covid; Corona (search for similar items in EconPapers)
JEL-codes: G1 G10 G17 G32 (search for similar items in EconPapers)
Date: 2020
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