Short Positions, Rally Fears and Option Markets
23 Pages Posted: 28 Jan 2010 Last revised: 13 May 2010
Date Written: July 26, 2009
Abstract
Index option pricing on world market indices are investigated using Lévy processes with no positive jumps. Economically this is motivated by the possible absence of longer horizon short positions while mathematically we are able to evaluate for such processes the probability of a Rally Before a Crash (RBC). Three models are used to effectively calibrate index options at an annual maturity and it is observed that positive jumps may be needed for FTSE, N225 and HSI. RBC probabilities are shown to have fallen by 10 points after July 2007. Typical implied volatility curves for such models are also described and illustrated. They have smirks and never smile.
Keywords: U-shaped measure change, Spectrally Negative Process, Scale Functions
JEL Classification: G1, G12, G13
Suggested Citation: Suggested Citation