Some easy-to-implement methods of calculating American futures option prices (original) (raw)

1995, Journal of Futures Markets

Options on various types of futures contracts (stock index, interest rate, currency, energy, metal and agricultural commodities) are currently traded on major exchanges across the world. By and large, these options are of the American type, i.e., they can be exercised any time prior to the option's maturity date. Black's (1976) European futures option formula ignores this early exercise possibility and hence underestimates the value of these options. Despite this obvious shortcoming, practitioners continue to use Black's European formula for many purposes, for example, to estimate American futures option values, to calculate margin requirements, and so forth [Wolf (1984)l. Because of its analytic and closed form nature, Black's formula is intuitively appealing and extremely user friendly. In these respects, the extant methods of American futures option valuation are, however, deficient although they yield more accurate option values. Building on some recent works [Lieu (1990); Chaudhury and Wei (1994); Chen and Scott (1993)], this article presents a new approach to the valuation of American futures options. The American futures option value (early exercise premium) is shown to be a multiple (proportion) of Black's (1 976) European futures option value. Aside from providing new Acknowledgment: Thanks to J. Wei and two anonymous referees for helpful comments. The usual disclaimer applies.