Quantity-Adjusting Options and Forward Contracts

20 Pages Posted: 2 Jan 2007

See all articles by David F. Babbel

David F. Babbel

University of Pennsylvania - The Wharton School - Finance and Insurance Departments; CRA International

Larry Eisenberg

New Jersey Institute of Technology

Abstract

Quantity-adjusting option and forward contracts deliver a payoff on a variable quantity of underlying. This article explains the use, pricing, and hedging of such contracts. The pricing of product options is also derived. Product options include quantity-adjusting options as a special case and pay off as a function of the prices of four risky assets. The pricing formula for these options is reduced to an expression in a two-dimensional density from a four-dimensional one. Closed form solutions in terms of the bivariate normal are obtained. Similar formulae in terms of the univariate normal are obtained for quantity-adjusting options. The normal distribution is absent from the expression for quantity-adjusting forwards. Product options also include sequential switching, or guru options. These are options which guarantee optimal asset selection at present dates among a fixed set of traded assets.

Keywords: Quantos, foreign exchange, options, quantity-adjusting

JEL Classification: G13

Suggested Citation

Babbel, David F. and Eisenberg, Laurence K., Quantity-Adjusting Options and Forward Contracts. Journal of Financial Engineering , Vol. 2, No. 2, pp. 89-126, 1993 , Available at SSRN: https://ssrn.com/abstract=954174

David F. Babbel (Contact Author)

University of Pennsylvania - The Wharton School - Finance and Insurance Departments ( email )

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Laurence K. Eisenberg

New Jersey Institute of Technology ( email )

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United States
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973 596-3074 (Fax)

HOME PAGE: http://som.njit.edu/people/eisenberg.php

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