S. Borovkova and F.J. Permana (The Netherlands)
Basket options, Asian options, option greeks, commodity futures, implied volatility, implied correlation.
We investigate the problem of valuation and hedging of Asian basket options. We extend the GLN (Generalized LogNormal) approach, introduced in Borovkova et al. [3], to Asian basket options and apply it to energy option mar kets. The GLN approach approximates the basket’s average value using a family of lognormal distributions: regular, shifted, negative or negative shifted lognormal. This ap proach provides closed form formulae for the option prices and the greeks, which is extremely useful for option traders. Inverting the spread option pricing formula allows us to im ply the correlation between the assets in the spread from the liquid spread option prices. Numerical simulations and the application of the method to energy markets show that the GLN approach performs remarkably well for option pric ing and delta hedging. We analyze the option’s sensitiv ity to volatilities and correlations. We also study the im plied correlation between crude oil and heating oil prices on NYMEX1 , derived from 1:1 crack spread option prices, and show the behavior to be comparable to the implied volatil ity smirk.
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