Optimal Liquidation of Options

Tim Leung and Xin Li

Chapter 6 in Optimal Mean Reversion Trading:Mathematical Analysis and Practical Applications, 2016, pp 129-161 from World Scientific Publishing Co. Pte. Ltd.

Abstract: For decades, options have been widely used as a tool for investment and risk management. As of 2012, the daily market notional for S&P 500 options is about US$90 billion and the average daily volume has grown rapidly from 119,808 in 2002 to 839,108 as of Jan 2013. Empirical studies on options returns often assume that the options are held to maturity. For every liquidly traded option, there is an embedded timing flexibility to liquidate the position through the market prior to expiry. Hence, an important question for effective risk management is: When is the best time to sell an option? In this chapter, we propose a risk-adjusted optimal timing framework to address this problem for a variety of options under different underlying price dynamics…

Keywords: Trading Strategies; Mean Reversion; Optimal Stopping; Optimal Switching; Stop-Loss; Stochastic Processes; Exchange-Traded Funds (ETFS); Ornstein–Uhlenbeck Model; Cox-Ingersoll-Ross (CIR) Model (search for similar items in EconPapers)
Date: 2016
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