Appendix: Some Source Codes

In VBA, (Visual Basic for Application) the code for a European call option
with the binomial model can be written as:

Function eCall(S, K, T, r, sigma, n)

u ¼ Exp(sigma*((T/n)^0.5))
d ¼ 1/u
r ¼ Exp(r*(T/n))
rp_u ¼ (r - d)/(r*(u - d))
rp_d ¼ 1/r - rp_u
eCall ¼ 0

For i ¼ 0 To n
eCall ¼ eCall + Application.Combin(n, i)*rp_u^i*rp_d^(n - i)* _
Application.Max(S*u^i*d^(n - i) - K, 0)
Next i
End Function

A more general binomial model, which also handles American-type options,

is given below. This code is written in VBA and handles some of the binomial
models such as Cox–Ross–Rubenstein (with and without Black–Scholes
smoothing) and the Leisen–Reimer model. The model also calculates the
Greeks, delta, gamma and theta. To calculate rho and vega, two trees must
be made with two different interest rates and volatilities, respectively

© The Author(s) 2017 461

J.R.M. Röman, Analytical Finance: Volume I,
DOI 10.1007/978-3-319-34027-2
462 Appendix: Some Source Codes

’ Input mBin ¼ Binomial model

’ mExe ¼ Put or Call (PUT_ or CALL_)
’ mTyp ¼ American or European

Function Binom(mBin As Long, mTyp As Long, mExe As Long, S As Double,

X As Double, T As Double, r As Double, v As Double, n As Long,
mDelta As Double, mGamma As Double, mTheta As Double)
Dim d1 As Double, d2 As Double, a As Double, b As Double
Dim aa As Double, vv As Double, U As Double, D As Double
Dim udd As Double, u_d As Double, p As Double, Dt As Double
Dim disc As Double, pe As Double, my As Double, m As Double
Dim q As Double, ermqdt As Double, pdash As Double, ans As Double
Dim idx As Long, i As Long, j As Long
Dim lSt1(0 To 2) As Double
Dim lC1(0 To 2) As Double
ReDim lSt(0 To n + 2) As Double
ReDim lC(0 To n + 2) As Double

d1 ¼ (Log(S / X) + (r + v * v / 2) * T) / (v * Sqr(T))
d2 ¼ d1 - v * Sqr(T)
Dt ¼ T / n
disc ¼ Exp(-r * Dt)

If (mBin ¼ CRR) Then

U ¼ Exp(v * Sqr(Dt))
D¼1/U
udd ¼ U / D
u_d ¼ U - D
p ¼ (1 / disc - D) / u_d
ElseIf (mBin ¼ PEG) Then
pe ¼ (Log(X / S)) / n
U ¼ Exp(pe + v * Sqr(Dt))
D ¼ Exp(pe - v * Sqr(Dt))
udd ¼ U / D
u_d ¼ U - D
p ¼ (1 / disc - D) / u_d
ElseIf (mBin ¼ JR) Then
’ Remark pu ¼ pd ¼ 0.5!
’ In this method the calc. of delta and gamma (rho+) is more
’ difficult since S0 <> S0*u*d. Use ORC method in this case!
my ¼ r - 0.5 * v * v
U ¼ Exp(my * Dt + v * Sqr(Dt))
D ¼ Exp(my * Dt - v * Sqr(Dt))
p ¼ 0.5
udd ¼ U / D
u_d ¼ U - D
 Appendix: Some Source Codes 463

ElseIf (mBin ¼ TIAN) Then

m ¼ Exp(r * Dt)
vv ¼ Exp(v * v * Dt)
U ¼ 0.5 * m * vv * (1 + vv + Sqr(vv * vv + 2 * vv - 3))
D ¼ 0.5 * m * vv * (1 + vv - Sqr(vv * vv + 2 * vv - 3))
udd ¼ U / D
u_d ¼ U - D
p ¼ (1 / disc - D) / u_d
ElseIf (mBin ¼ LR) Then
q¼0 ’ No yield
ermqdt ¼ Exp((r - q) * Dt)
d2 ¼ BSDTwo(S, X, r, q, T, v)
p ¼ PPNormInv(d2, n)
pdash ¼ PPNormInv(d2 + v * Sqr(T), n)
U ¼ ermqdt * pdash / p
D ¼ ermqdt * (1 - pdash) / (1 - p)
udd ¼ U / D
u_d ¼ U - D
End If

’ initialize stock prices at maturity log(a^b) ¼ b*log(a)

lSt(0) ¼ S * D ^ n

For i ¼ 1 To n
lSt(i) ¼ lSt(i - 1) * udd
Next i

’ initialize option prices at maturity n

For i ¼ 0 To n
lC(i) ¼ Max(0, bC(mExe, lSt(i), X))
Next i

idx ¼ find_opt_index(lSt, X, n)

’ step back through the tree

For j ¼ n - 1 To 2 Step -1
For i ¼ 0 To j
lC(i) ¼ disc * (p * lC(i + 1) + (1 - p) * lC(i))
lSt(i) ¼ lSt(i) / D
If (mTyp ¼ AMERICAN) Then
lC(i) ¼ Max(lC(i), bC(mExe, lSt(i), X))
End If
If (BS_Smoothing) Then
If (j ¼ n - 1) Then
If (i >¼ idx And i <¼ idx + 4) Then
464 Appendix: Some Source Codes

lC(i) ¼ GBlackScholes(mExe, lSt(i), X, T / n, r, r, v)

End If
End If
End If
Next i
Next j

’ save option value, used for calculating hedge parameters

mTheta ¼ lC(1) / Dt ’ For calculating Theta.

For i ¼ 0 To 1
lC1(i) ¼ disc * (p * lC(i + 1) + (1 - p) * lC(i))
lSt1(i) ¼ lSt(i) / D

If (mTyp ¼ AMERICAN) Then

lC1(i) ¼ Max(lC1(i), bC(mExe, lSt1(i), X))
End If
Next i

ans ¼ disc * (p * lC1(1) + (1 - p) * lC1(0))

If (mTyp ¼ AMERICAN) Then ans ¼ Max(ans, bC(mExe, S, X))

mGamma ¼ ((lC(2) - lC(1)) / (lSt(2) - lSt(1)) - _

(lC(1) - lC(0)) / (lSt(1) - lSt(0))) / (0.5 * (lSt(2) - lSt(0)))
mDelta ¼ (lC1(1) - lC1(0)) / (lSt1(1) - lSt1(0))
mTheta ¼ (mTheta - ans / Dt) / 2
If (mBin ¼ TIAN) Then mTheta ¼ mTheta / 2
Binom ¼ ans
End Function

To find the index closest to the strike for the Black–Scholes smoothing, we use
the following function:

Function find_opt_index(lSt() As Double, mX As Double, n As Long)

Dim idx As Long, i As Long

idx ¼ 0

For i ¼ 0 To n - 1
If (lSt(i) >¼ mX) Then Exit For
idx ¼ idx + 1
Next i
find_opt_index ¼ idx - 2
End Function
 Appendix: Some Source Codes 465

The boundary for call and put, is given by:

Function bC(aIsCall As Long, S As Double, X As Double) As Double

If aIsCall Then
bC ¼ S - X
Else
bC ¼ X - S
End If
End Function

We also use two functions from the Black–Scholes model:

Function BSDTwo(S As Double, X As Double, r As Double, q As Double, _

T As Double, v As Double) As Double
BSDTwo ¼ (Log(S / X) + (r - q - 0.5 * v * v) * T) / (v * Sqr(T))
End Function
double BSDTwo(double S, double X, double r, double q, double T,

Function BlackScholes(mCall As Long, S As Double, X As Double, _

T As Double, r As Double, b As Double, _
v As Double) As Double
Dim d1 As Double, d2 As Double

d1 ¼ (Log(S / X) + (b + v * v / 2) * T) / (v * Sqr(T))
d2 ¼ d1 - v * Sqr(T)

If (mCall) Then
BlackScholes ¼ S*Exp((b - r) * T)*CND(d1) - X*Exp(-r*T)*CND(d2)
Else
BlackScholes ¼ X*Exp(-r*T)*CND(-d2) - S*Exp((b - r)*T)*CND(-d1)
End If
End Function

In the Leisen–Reimer model we use the Peizer–Pratt inversion formula:

Function PPNormInv(z As Double, n As Long) As Double

Dim c1 As Double

n ¼ 2 * Int(n / 2) + 1 ’ ¼¼ odd(n);
c1 ¼ Exp(-((z / (n + 1 / 3 + 0.1 / (n + 1))) * _
(z / (n + 1 / 3 + 0.1 / (n + 1)))) * (n + 1 / 6))
PPNormInv ¼ 0.5 + Sgn(z) * Sqr((0.25 * (1 - c1)))
End Function
466 Appendix: Some Source Codes

The function CND to calculate the cumulative normal eistribution is given

in VBA below. This function below gives the normal distribution function
with a maximum error of 108:

do Function CND(X As Double) As Double

Dim sign As Long
Dim x2, q0, q1, q2 As Double

If (X < 0) Then
X ¼ -X
sign ¼ -1
ElseIf (X > 0) Then
sign ¼ 1
Else ’ (x ¼ 0.0)
CND ¼ 0.5
Exit Function
End If

If (X > 20) Then

If (sign < 0) Then
CND ¼ 0
Else
CND ¼ 1
End If
Exit Function
End If

X ¼ X*0.707106781186547
x2 ¼ X*X
If (X < 0.46875) Then
q1 ¼ 3209.37758913847 + x2*(377.485237685302 + x2* _
(113.86415415105 + x2*(3.16112374387057 + x2* _
0.185777706184603)))

q2 ¼ 2844.23683343917 + x2*(1282.61652607737 + x2* _

(244.024637934444 + x2*(23.6012909523441 + x2)))
CND ¼ 0.5*(1 + sign*X*q1/q2)
ElseIf (X < 4) Then
q1 ¼ X*(8.88314979438838 + X*(0.56418849698867 + X* _
2.15311535474404E-08))
q1 ¼ X*(881.952221241769 + X*(298.6351381974 + X* _
(66.1191906371416 + q1)))
q1 ¼ 1230.339354798 + X*(2051.07837782607 + X*(1712.04761263407 _
+ q1))
 Appendix: Some Source Codes 467

q2 ¼ X*(117.693950891312 + X * (15.7449261107098 + X))

q2 ¼ X*(3290.79923573346 + X*(1621.38957456669 + X* _
(537.18110186201 + q2)))
q2 ¼ 1230.33935480375 + X*(3439.36767414372 + X* _
(4362.61909014325 + q2))

CND ¼ 0.5*(1 + sign*(1 - Exp(-x2)*q1/q2))

Else
q0 ¼ 1/x2
q1 ¼ 6.58749161529838E-04 + q0*(1.60837851487423E-02 + q0* _
(0.125781726111229 + q0*(0.360344899949804 + q0* _
(0.305326634961232 + q0*1.63153871373021E-02))))

q2 ¼ 2.33520497626869E-03 + q0*(6.05183413124413E-02 + q0* _

(0.527905102951428 + q0*(1.87295284992346 + q0*´_
(2.56852019228982 + q0))))
CND ¼ 0.5*(1 + sign*(1 - Exp(-x2)/X*(0.564189583547756 - _
q0*q1/q2)))
End If
End Function

Function nd(X As Double) As Double

nd ¼ 1/Sqr(2*3.141592654)*Exp(-X*X/2)
End Function

Below we give an example of how to write a C++ program to solve option

prices with the Crank–Nicholson method. The model also calculates the
Greeks, delta, gamma and theta. To calculate rho and vega, two grids must
be made with two different interest rates and volatilities, respectively, The
function bC is the same as for the binomial model.

double CrNi(double S, double K, double T, double sig, double r,

int N, int Nj, double div, int mIsCall,
int mIsAmerican, double D, double &mDelta,
double &mGamma, double &mTheta)
{
double dt ¼ T/N;
double dx ¼ sig*sqrt(D*dt);
double nu ¼ r - div - 0.5*sig*sig;
double edx ¼ exp(dx);
double pu ¼ -0.25*dt*((sig/dx)*(sig/dx) + nu/dx);
double pm ¼ 1.0 + 0.5*dt*(sig/dx)*(sig/dx) + 0.5*r*dt;
468 Appendix: Some Source Codes

double pd ¼ -0.25*dt*((sig/dx)*(sig/dx) - nu/dx);

double *St, *C[2], lambda_U, lambda_L;

St ¼ new double [2*Nj + 3];

C[0] ¼ new double [2*Nj + 3];
C[1] ¼ new double [2*Nj + 3];

// Initialize the asset prices at maturity.

St[0] ¼ S*exp(-Nj*dx);
for (int j ¼ 1; j <¼ 2*Nj; j++) {
St[j] ¼ edx*St[j-1];
}

// Initialize the option values at maturity.

for (int j ¼ 0; j <¼ 2*Nj; j++)
C[0][j] ¼ max(0.0, bC(mIsCall, St[j], K));

// Compute derivative boundary condition

if (mIsCall) {
lambda_U ¼ St[2*Nj] - St[2*Nj-1];
lambda_L ¼ 0.0;
}
else {
lambda_L ¼ -(St[1] - St[0]);
lambda_U ¼ 0.0;
}

// Step backwards through the lattice

for (int i ¼ N - 1; i >¼ 0; i--) {
solve_CN(C, pu, pm, pd, lambda_L, lambda_U, Nj);
if (i ¼¼ 0) mTheta ¼ (C[0][Nj] - C[1][Nj])/dt;

// Apply early exercise condition

for (int j ¼ 0; j <¼ 2*Nj; j++) {
if (mIsAmerican)
C[0][j] ¼ max(C[1][j], bC(mIsCall, St[j], K));
else
C[0][j] ¼ C[1][j];
}
}
 Appendix: Some Source Codes 469

mDelta ¼ (C[1][Nj+1] - C[1][Nj-1])/(St[Nj+1] - St[Nj-1]);

mGamma ¼ ((C[0][Nj+2] - C[0][Nj]) /(St[Nj+2] - St[Nj]) -
(C[0][Nj] - C[0][Nj-2])/(St[Nj] - St[Nj-2]))/
(0.5*(St[Nj+2] - St[Nj-2]));

return C[0][Nj];
}

double solve_CN(double **C, double pu, double pm, double pd,

double lambda_L, double lambda_U, int Nj)
{
double *pmp; // ¼ array();
double *pp; // ¼ array();

pp ¼ new double [2*Nj + 3];

pmp ¼ new double [2*Nj + 3];

// Substitute boundary condition at j ¼ -Nj into j ¼ -Nj + 1

pmp[1] ¼ pm + pd;
pp [1] ¼ -pu*C[0][2] - (pm - 2.0)*C[0][1] –
pd*C[0][0] + pd*lambda_L;

// Eliminate the upper diagonal

for (int j ¼ 2; j < 2*Nj; j++) {
pmp[j] ¼ pm - pu*pd/pmp[j-1];
pp [j] ¼ - pu*C[0][j+1] - (pm - 2.0)*C[0][j]
- pd*C[0][j-1] - pp[j-1]*pd/pmp[j-1];
}

// Use boundary condition at j ¼ Nj and equation at j ¼ Nj - 1

C[1][2*Nj] ¼ (pp[2*Nj-1] + pmp[2*Nj-1]*lambda_U)/
(pu + pmp[2*Nj-1]);
C[1][2*Nj-1] ¼ C[1][2*Nj] - lambda_U;

// Back substitution
for (int j ¼ 2*Nj - 2; j >¼ 1; j--)
C[1][j] ¼ (pp[j] - pu*C[1][j+1])/pmp[j];

C[1][0] ¼ C[1][1] - lambda_L;

delete [] pp;
delete [] pmp;
}
A VBA code for the Black–Scholes model (i.e., with continuous dividends)
and the Greeks are given below:
470 Appendix: Some Source Codes

Function BlackScholes(mCall As Integer, s As Double, x As Double, _

T As Double, r As Double, b As Double, _
v As Double) As Double
Dim d1 As Double, d2 As Double

d1 ¼ (Log(s/x) + (b + v*v/2)* T)/(v*Sqr(T))

d2 ¼ d1 - v * Sqr(T)

if (mCall) Then
if (T > 0.0)
BlackScholes ¼ s*Exp((b - r)*T)*CND(d1)
- x*Exp(-r * T)*CND(d2)
Else
BlackScholes ¼ WorksheetFunction.Max(s - x, 0)
Else
if (T > 0.0)
BlackScholes ¼ x*Exp(-r*T)*CND(-d2)
- s*Exp((b - r)*T)*CND(-d1)
Else
BlackScholes ¼ WorksheetFunction.Max(x - s, 0)
End Function

Function Delta(mCall As Integer, s As Double, x As Double, _

T As Double, r As Double, b As Double, _
v As Double) As Double
Dim d1 As Double

If (T > 0) Then
d1 ¼ (Log(s/x) + (b + v*v/2)*T)/(v*Sqr(T))
Else
d1 ¼ (Log(s/x) + (b + v*v/2)*T)/(v*Sqr(T))

If (mCall) Then
Delta ¼ Exp((b - r)*T)*CND(d1)
Else
Delta ¼ Exp((b - r)*T)*(CND(d1) - 1)
End If
End Function

Function Gamma(s As Double, x As Double, T As Double, _

r As Double, b As Double, v As Double) As Double
Dim d1 As Double

d1 ¼ (Log(s/x) + (b + v*v/2)*T)/(v*Sqr(T))
Gamma ¼ nd(d1)*Exp((b - r)*T)/(s*v*Sqr(T))
End Function
 Appendix: Some Source Codes 471

Function Vega(s As Double, x As Double, T As Double, r As Double,_

b As Double, v As Double) As Double
Dim d1 As Double

d1 ¼ (Log(s/x) + (b + v*v/2)*T)/(v*Sqr(T))
Vega ¼ s*Exp((b - r)*T)*nd(d1)*Sqr(T)
End Function

Function Theta(mCall As Integer, s As Double, x As Double, _

T As Double, r As Double, b As Double, _
v As Double) As Double
Dim d1 As Double
Dim d2 As Double

d1 ¼ (Log(s/x) + (b + v*v/2)*T)/(v*Sqr(T))
d2 ¼ d1 - v*Sqr(T)

If (mCall) Then
Theta ¼ -s*Exp((b - r)*T)*nd(d1)*v/(2*Sqr(T)) – _
(b - r)*s*Exp((b - r)*T)*CND(d1) - r*x*Exp(-r*T)*CND(d2)
Else
Theta ¼ -s*Exp((r - b)*T)*nd(d1)*v/(2*Sqr(T)) + _
(b - r)*s*Exp((b - r)*T)*CND(-d1) + r*x*Exp(-r*T)*CND(-d2)
End If
End Function

Function Rho(mCall As Integer, s As Double, x As Double, _

T As Double, r As Double, b As Double, _
v As Double) As Double
Dim d1 As Double
Dim d2 As Double

d1 ¼ (Log(s/x) + (b + v*v/2)*T)/(v*Sqr(T))
d2 ¼ d1 - v*Sqr(T)

If (mCall) Then
If (b ¼ 0) Then
Rho ¼ -T*BlackScholes(1, s, x, T, r, b, v)
Else
Rho ¼ T*x*Exp(-r*T)*CND(d2)
End If
Else
If (b ¼ 0) Then
Rho ¼ -T*BlackScholes(0, s, x, T, r, b, v)
Else
472 Appendix: Some Source Codes

Rho ¼ -T*x*Exp(-r*T)*CND(-d2)
End If
End If
End Function

A VBA implementation of the RollGeske–Whaley model is given below

Public Const BIGNUM As Long ¼ 100000000

Public Const EPSILON As Double ¼ 0.00001

Function RollGeskeWhaley(s As Double, x As Double, v As Double, _

r As Double, T As Double, D As Double, _
TD As Double) As Double
Dim SX As Double, ci As Double, HighS As Double, LowS As Double
Dim a1 As Double, a2 As Double, b1 As Double, b2 As Double,
Dim c As Double, i As Double

SX ¼ s - D * Exp(-r * TD)

’ Not optimal to exercise.....

If (D <¼ x*(1 - Exp(-r*(T - TD)))) Then
RollGeskeWhaley ¼ BlackScholes(mCall, SX, x, T, r, r, v)
Exit Function
End If
ci ¼ BlackScholes(mCall, SX, x, T - TD, r, r, v)
HighS ¼ s

Do While ((ci - HighS - D + x) > 0 And (HighS < BIGNUM))

HighS ¼ 2*HighS
ci ¼ BlackScholes(mCall, HighS, x, T - TD, r, r, v)
Loop

If (HighS < BIGNUM) Then

RollGeskeWhaley ¼ BlackScholes(mCall, SX, x, T, r, r, v)
Exit Function
End If

LowS ¼ 0
i ¼ HighS * 0.5
ci ¼ BlackScholes(mCall, i, x, T - TD, r, r, v)

’ Find the critical Stock Price with Bisection.

Do While (Abs(ci - i - D + x) > EPSILON And _
(HighS - LowS) > EPSILON)
 Appendix: Some Source Codes 473

If ((ci - i - D + x) < 0) Then

HighS ¼ i
Else
LowS ¼ i
End If

i ¼ (HighS + LowS)/2
ci ¼ BlackScholes(mCall, i, x, T - TD, r, r, v)
Loop

a1 ¼ (Log(SX/x) + (r + v*v/2)*T)/(v*Sqr(T))
a2 ¼ a1 - v*Sqr(T)
b1 ¼ (Log(SX/i) + (r + v*v/2)*TD)/(v*Sqr(TD))
b2 ¼ b1 - v*Sqr(TD)

c ¼ SX*(CND(b1) + M(a1, -b1, Sqr(TD / T))) - _

x*Exp(-r*T)*M(a2, -b2, -Sqr(TD/T)) – _
(x - D)*Exp(-r*TD)*CND(b2)
RollGeskeWhaley ¼ c
End Function

Where the function for the bivariate normal distribution is given below.
The bivariate normal distribution is defined as:
(    2 )
1 ðx  μx Þ2 2λðx  μx Þ y  μy y  μy
Mðx; y; λÞ ¼ pffiffiffiffiffiffiffiffiffiffiffiffiffi exp  þ ;
2πσ x σ y 1  λ2 σ 2x σxσy σ 2y

where μx and μy is the mean of x and y, σ x and σ y the standard deviations. The
correlation function λ is defined by
σ xy
λ ¼ corrðx; yÞ ¼ :
σxσy

Hereby, the probability measure p(x, y) is given by

ðx ðy
pðx; yÞ ¼ f ðξ; ζ; λÞdξdζ:
1 1

A VBA implementation is given below

474 Appendix: Some Source Codes

’ Calculates the Cumulative Probability in Bivariate Normal dist.

’ with |e(x)| < 1.0e-7

Function M(a As Double, b As Double, c As Double) As Double

Dim sa As Double, sb As Double, r1 As Double, r2 As Double
Dim D As Double

sa ¼ 1
sb ¼ 1

If (a <¼ 0 And b <¼ 0 And c <¼ 0) Then

M ¼ MM(a, b, c)
ElseIf (a*b*c <¼ 0) Then
If (b > 0 And c > 0) Then
M ¼ CND(a) - MM(a, -b, -c)
ElseIf (a > 0 And c > 0) Then
M ¼ CND(b) - MM(-a, b, -c)
ElseIf (a > 0 And b > 0) Then
M ¼ CND(a) + CND(b) - 1 - MM(-a, -b, c)
End If
Else
If (a < 0) Then sa ¼ -1
If (b < 0) Then sb ¼ -1
r1 ¼ (c*a - b)*sa/Sqr(a*a - 2*a*b*c + b*b)
r2 ¼ (c*b - a)*sb/Sqr(a*a - 2*a*b*c + b*b)
D ¼ (1 - sa*sb)/4
M ¼ MM(a, 0, r1) + MM(b, 0, r2) - D
End If
End Function

Function MM(a As Double, b As Double, c As Double) As Double

Dim aa As Double, bb As Double
Dim i As Integer, j As Integer
Dim am(4) As Double
Dim bm(4) As Double

am(0) ¼ 0.325303
am(1) ¼ 0.4211071
am(2) ¼ 0.1334425
am(3) ¼ 0.006374323

bm(0) ¼ 0.1337764
bm(1) ¼ 0.6243247
bm(2) ¼ 1.3425378
bm(3) ¼ 2.2626645
 Appendix: Some Source Codes 475

MM ¼ 0
aa ¼ a/Sqr(2*(1 - c*c))
bb ¼ b/Sqr(2*(1 - c*c))

For i ¼ 0 To 4
For j ¼ 0 To 4
MM ¼ MM + am(i)*am(j)*f(bm(i), bm(j), aa, bb, c)
Next j
Next i
MM ¼ MM*Sqr(1 - c*c)/3.121592654
End Function

Function f(x As Double, y As Double, a As Double, b As Double, _

c As Double) As Double
f ¼ Exp(a*(2*x - a) + b*(2*y - b) + 2*c*(x - a)*(y - b))
End Function

A VBA implementation of Barone–Adesi–Whaley is given below:

Function BaroneAdesiWhaleyCall(s As Double, x As Double, _

v As Double, r As Double, _
T As Double, b As Double) As Double
Dim sk As Double, n As Double, K As Double, d1 As Double
Dim q2 As Double, a2 As Double

If (b >¼ r) Then
BaroneAdesiWhaleyCall ¼ BlackScholes(mCall, s, x, T, r, b, v)
Exit Function
End If

sk ¼ kc(x, T, r, b, v)
n ¼ 2*b/(v*v)
K ¼ 2*r/(v*v*(1 - Exp(-r*T)))
d1 ¼ (Log(sk/x) + (b + v*v/2)*T)/(v*Sqr(T))
q2 ¼ (-(n - 1) + Sqr((n - 1)*(n - 1) + 4*K))/2
a2 ¼ (sk/q2)*(1 - Exp((b - r)*T)*CND(d1))

If (s < sk) Then

BaroneAdesiWhaleyCall ¼ BlackScholes(mCall, s, x, T, r, b, v)_
+ a2*(s/sk) ^ q2
Exit Function
End If

BaroneAdesiWhaleyCall ¼ s - x
End Function
476 Appendix: Some Source Codes

Function BaroneAdesiWhaleyPut(s As Double, x As Double, _

v As Double, r As Double, _
T As Double, b As Double) As Double
Dim sk As Double, n As Double, K As Double, d1 As Double
Dim q1 As Double, a1 As Double

sk ¼ kp(x, T, r, b, v)
n ¼ 2*b/(v*v)
K ¼ 2*r/(v*v*(1 - Exp(-r*T)))
d1 ¼ (Log(sk/x) + (b + v*v/2)*T)/(v*Sqr(T))
q1 ¼ (-(n - 1) - Sqr((n - 1)*(n - 1) + 4*K))/2
a1 ¼ -(sk/q1)*(1 - Exp((b - r)*T)*CND(-d1))

If (s > sk) Then

BaroneAdesiWhaleyPut ¼ BlackScholes(mPUT, s, x, T, r, b, v) _
+ a1*(s/sk) ^ q1
Exit Function
End If

BaroneAdesiWhaleyPut ¼ x - s
End Function

Function kc(x As Double, T As Double, r As Double, b As Double, _

v As Double) As Double
’ Calculation of seed value, Si
Dim M As Double, q2u As Double, Su As Double, h2 As Double
Dim Si As Double, d1 As Double, q2 As Double, LHS As Double
Dim RHS As Double, bi As Double, E As Double, K As Double

M ¼ 2*r/(v*v)
q2u ¼ 1 + 2*M
Su ¼ x/(1 - 1/q2u)
h2 ¼ -(b*T + 2*v*Sqr(T))*x/(Su - x)
Si ¼ x + (Su - x)*(1 - Exp(h2))

If (T ¼ 0) Then T ¼ 0.000000001
K ¼ 2*r/(v*v*(1 - Exp(-r*T)))
d1 ¼ (Log(Si/x) + (b + v*v/2)*T)/(v*Sqr(T))
q2 ¼ 1 + 2*K
LHS ¼ Si - x
RHS ¼ BlackScholes(mCall, Si, x, T, r, b, v) + _
(1 - Exp((b - r)*T)*CND(d1))*Si/q2
bi ¼ Exp((b - r)*T)*CND(d1)*(1 - 1/q2)
bi ¼ bi + (1 - Exp((b - r)*T)*CND(d1)/(v*Sqr(T)))/q2
E ¼ 0.000001
 Appendix: Some Source Codes 477

’ Newton-Raphson algorithm for finding critical price Si

Do While (Abs(LHS - RHS)/x > E)
Si ¼ (x + RHS - bi*Si)/(1 - bi)
d1 ¼ (Log(Si/x) + (b + v*v/2)*T)/(v*Sqr(T))
LHS ¼ Si - x
RHS ¼ BlackScholes(mCall, Si, x, T, r, b, v) + _
(1 - Exp((b - r)*T)*CND(d1))*Si/q2
bi ¼ Exp((b - r)*T)*CND(d1)*(1 - 1/q2)
bi ¼ bi + (1 - Exp((b - r)*T)*CND(d1)/(v*Sqr(T)))/q2
Loop
kc ¼ Si
End Function

Function kp(x As Double, T As Double, r As Double, b As Double, _

v As Double) As Double
’ Calculation of seed value, Si
Dim M As Double, q1u As Double, Su As Double, h1 As Double
Dim Si As Double, d1 As Double, q1 As Double, LHS As Double
Dim RHS As Double, bi As Double
Dim E As Double, K As Double, n As Double

n ¼ 2*b/(v*v)
M ¼ 2*r/(v*v)
q1u ¼ (-(n - 1) - Sqr((n - 1)*(n - 1) + 4*M))/2
Su ¼ x/(1 - 1/q1u)
h1 ¼ (b*T - 2*v*Sqr(T))*x/(x - Su)
Si ¼ Su + (x - Su)*Exp(h1)

If (T ¼ 0) Then T ¼ 0.000000001
K ¼ 2*r/(v*v*(1 - Exp(-r*T)))
d1 ¼ (Log(Si/x) + (b + v*v/2)*T)/(v*Sqr(T))
q1 ¼ (-(n - 1) - Sqr((n - 1)*(n - 1) + 4*K))/2
LHS ¼ x - Si
RHS ¼ BlackScholes(mPUT, Si, x, T, r, b, v) - _
(1 - Exp((b - r)*T)*CND(-d1))*Si/q1
bi ¼ -Exp((b - r)*T)*CND(-d1)*(1 - 1/q1)
bi ¼ bi - (1 + Exp((b - r)*T)*CND(-d1)/(v*Sqr(T)))/q1
E ¼ 0.000001

’ Newton Raphson algorithm for finding critical price Si

Do While (Abs(LHS - RHS)/x > E)
Si ¼ (x - RHS + bi*Si)/(1 + bi)
d1 ¼ (Log(Si/x) + (b + v*v/2)*T)/(v*Sqr(T))
LHS ¼ x - Si
478 Appendix: Some Source Codes

RHS ¼ BlackScholes(mPUT, Si, x, T, r, b, v) - _

(1 - Exp((b - r)*T)*CND(-d1))*Si/q1
bi ¼ -Exp((b - r)*T)*CND(-d1)*(1 - 1/q1)
bi ¼ bi - (1 + Exp((b - r)*T)*CND(-d1)/(v*Sqr(T)))/q1
Loop
kp ¼ Si
End Function

A VBA implementation of the Bjerksund-Stensland model is given below:

Function BjerksundStenslandCall(s As Double, x As Double, _

v As Double, r As Double, _
T As Double, b As Double) _
As Double
Dim Beta As Double, BInfinity As Double, B0 As Double
Dim ht As Double, i As Double
Dim alpha As Double, ss As Double

If (b >¼ r) Then // Never optimal to exersice before maturity

BjerksundStenslandCall ¼ BlackScholes(mCall, s, x, T, r, b, v)
Else
Beta ¼ (0.5 - b/(v*v)) + Sqr((b/(v*v) - 0.5)*(b/(v*v) - 0.5)_
+ 2*r/(v*v))
BInfinity ¼ Beta/(Beta - 1)*x
B0 ¼ Max(x, r/(r - b)*x)
ht ¼ -(b*T + 2*v*Sqr(T))*B0/(BInfinity - B0)
i ¼ B0 + (BInfinity - B0)*(1 - Exp(ht))
alpha ¼ (i - x)*(i ^ (-Beta))

If (s >¼ i) Then
BjerksundStenslandCall ¼ s - x
Exit Function
End If

ss ¼ alpha*(s^Beta) - alpha*phi(s, T, Beta, i, i, r, b, v)

ss ¼ ss + (phi(s, T, 1, i, i, r, b, v) _
- phi(s, T, 1, x, i, r, b, v))
ss ¼ ss - (x*phi(s, T, 0, i, i, r, b, v) _
- x*phi(s, T, 0, x, i, r, b, v))
BjerksundStenslandCall ¼ ss
End If
End Function
 Appendix: Some Source Codes 479

Function BjerksundStenslandPut(s As Double, x As Double,

v As Double, r As Double, _
T As Double, b As Double) As Double
BjerksundStenslandPut ¼ _
BjerksundStenslandCall(x, s, v, r - b, T, -b)
End Function

Function phi(s As Double, T As Double, gamma As Double, _

h As Double,_i As Double, r As Double, b As Double,_
v As Double) As Double
Dim lambda As Double, D As Double, kappa As Double, f As Double

lambda ¼ (-r + gamma*b + 0.5*gamma*(gamma - 1)*(v*v))*T

D ¼ -(Log(s/h) + (b + (gamma - 0.5)*(v*v))*T)/(v*Sqr(T))
kappa ¼ 2*b/((v*v)) + (2*gamma - 1)
f ¼ CND(D) - ((i/s)^kappa)*CND(D - 2*Log(i/s)/(v*Sqr(T)))
phi ¼ Exp(lambda)*(s^gamma)*f
End Function
 References

Albanese, C., & Campolieti, G. (2006). Advanced derivatives pricing and risk manage-
ment. San Diego: Elsevier Academic Press.
Barone-Adesi, G., et.al. (1999). VaR without correlations for nonlinear portfolios.
Journal of Futures Markets, 19, 583–602.
Barucci, E. (2003). Financial markets theory. New York: Springer.
Berkowitz, J., & O’Brien, J. (2002). How accurate are value-at-risk models at
commercial banks? Journal of Finance, 57, 1093–1111.
Björk, T. (1998). Arbitrage theory in continuous time. Oxford: Oxford University Press.
Black, F. (1976). The pricing of commodity contracts. Journal of financial economics, 3
(1), 167–179.
Black, F., & Scholes, M. (1973). The pricing of options and corporate liabilities. The
Journal of Political Economy, 8, 637–654.
Campbell, S. D. (2005). A review of backtesting and backtesting procedures. Finance
and economics, discussion series Divisions of Research and Statistics and Monetary
Affairs. Federal Reserve Board, Washington, DC.
Clewlow, L., & Strickland, C. (2000). Implementing derivative models. London:
Wiley.
Conroy, R. M. (2003). Binomial option pricing. Darden Graduate School of Business
Administration, University of Virginia. UVA-F-0943
Cox, J., Ross, S. A., & Rubenstein, M. (1979). Option pricing: A simplified approach.
Journal of Financial Economics, 7(1979), 145–166.
Curran, M. (1994). Valuing Asian and Portfolio options by conditioning on the
geometric mean price. Management Science, 40(12), 1705–1711.
Dana, R.-A., & Jeanblanc, M. (2007). Financial markets in continuous time. Berlin:
Springer.

© The Author(s) 2017 481

J.R.M. Röman, Analytical Finance: Volume I,
DOI 10.1007/978-3-319-34027-2
482 References

Davis, M., & Etheridge, A. (2006). Louis Bachelier’s theory of speculation: The origins of
modern finance. Princeton: Princeton University Press.
Derman, E. (1996). Model risk. Goldman Sachs Quantitative Strategies Research
Notes.
DeRosa, D. F. (2000). Options on foreign exchange. New York: Wiley.
Drezner, Z. (1978). Computation of the bivariate normal integral. Mathematics of
Computation, 32, 277–279.
Glasserman, P. (2000). Monte Carlo methods in financial engineering. New York:
Springer.
Glasserman, P. (2003). Monte Carlo methods in financial engineering. New York:
Springer.
Glasserman, P. (2004). Monte Carlo methods in financial engineering. New York:
Springer.
Haug, E. (1997). The complete guide to option pricing formulas. New York: McGraw-
Hill.
Ho, T. S. Y., & Lee, S. B. (2005). Securities valuations. Oxford: Oxford University
Press.
Hull, J. Option futures and other derivatives. (9th Edition) Prentice-Hall. ISBN-
13: 978-0133456318
Hunt, P. J., & Kennedy, J. E. (2004). Financial derivative in theory and practise.
Chichester: Wiley.
Ingersoll, J. E. (1987). Theory of financial decision making. Totowa: Rowman &
Littlefield.
Jarrow, R., & Rudd, A. (1983). Option pricing (pp. 183–188). Homewood: Dow
Jones-Irwin.
Jorion, P. (2001). Value at risk: The new benchmark for managing financial risk.
New York: McGraw-Hill.
Kerry B. (2005). A cource in derivative securities. New York: Springer.
Kijima, M. (2003). Stochastic processes with application to finance. London: Chapman
& Hall.
Kwok, Y.-K. (2008). Mathematical models of financial derivatives. New York: Springer.
Leisen, D. (1998). Pricing the American put option: A detailed convergence analysis
for binomial models. Journal of Economic Dynamics and Control, 22, 1419–1444.
Leisen, D., & Reimer, M. (1996). Binomial models for option valuation – Examine
and improving convergence. Applied Mathematical Finance, 3, 319–346.
London, J. (2005). Modeling derivatives in C++. London: Wiley.
Longstaff, F. A. (1989). Pricing options with extendible maturities. Journal of Finance,
45(3), 935–957.
Martin, J. S. (2001). Applied math for derivatives. London: Wiley.
Merton, R. C. (1973). Theory of rational option pricing. The Bell Journal of Economics
and Management Science, 4(1), 141–183.
Merton, C. R. (1976). Option pricing when stock returns are discontinuous. Journal
of Financial Economics, 3, 167–179.
 References 483

Munk, C. (2003). Fixed income analysis: Securities, pricing and risk management.
http://citeseerx.ist.psu.edu/viewdoc/download?doi¼10.1.1.129.9912&rep¼rep1&
type¼pdf
Neftci, S. N. (2000). An introduction to the Mathematics of Financial Derivatives.
New York: Academic Press.
Neftci, S. N. (2004). Principles of financial engineering. San Diego: Academic Press.
Pratt, J. W. (1968). A normal approximation for binomial, F, Beta, and other
common, related tail probabilities, II. The Journal of the American Statistical
Association, 63, 1457–1483.
Rebonato, R. (2001). Managing model risk. In C. Alexander (Ed.), Handbook of risk
management. FT-Prentice Hall.
Reiner, E., & Rubinstein, M. (1991). Breaking down the barriers. Risk, 4, 28–35.
Rendleman, R. J., & Bartter, B. J. (1980). The pricing of options on debt securities.
The Journal of Financial and Quantitative Analysis, 15, 11–24.
Ross, S. M. (1983). Stochastic processes. New York: Wiley.
Rubinstein, M. (2000). On the relation between binomial and trinomial option
pricing models. The Journal of Derivatives, 8(2), 47–50.
Schweizer, M. (2012). On Bermudan options. ETH Zurich.
Shreve, Steven. (2004). Stochastic calculus for finance II. New York: Springer.
Shreve, Steven. (2005). Stochastic calculus for finance I. New York: Springer.
Sidenius, J. (2000). LIBOR market models in practice. Journal of Computational
Finance, 3(3), 75–99.
Stoklosa, J. (2007). Studies of barrier options and their sensitivities. The University of
Melbourne.
Tian, Y. (1993). A modified lattice approach to option pricing. Journal of Futures
Markets, 13(5), 564–577.
Trigeorgis, L. (1991). A log-transformed binomial numerical analysis for valuing
complex multi-option investments. Journal of Financial and Quantitative Analysis,
26(3), 309–326.
Wilmott, P. (2000). On quantitative finance. Chichester: Wiley.
 Index
A arbitrage strategy, 39, 271, 277
absolute continuous, 118
adapted, 96–100, 112, 205, 245, 249,
261, 268, 276–9
all-or-nothing options, 293
American call option, 37, 48, 51, 229–35
American contract, 113, 233–5
American double-no-touch option, 301
American knock-in option, 303
American knock-out option, 303
American no-touch option, 301, 302
American option, vii, viii, 29, 56, 62,
77, 113–17, 188, 212, 228–39,
296, 369
American put option, 48, 54–6, 61, 77,
218, 228–31
American style digital, 296
arbitrage, vii, 21–3, 31–43, 92, 158,
160–2, 196, 204, 211–15, 230–3,
249, 255, 267–78, 282, 313, 329,
337, 340, 359, 372, 380
arbitrage condition, 38, 92, 211, 215
arbitrage portfolio, 31
Note: Page numbers followed by “n” denote footnotes.
© The Author(s) 2017
J.R.M. Röman, Analytical Finance: Volume I,
DOI 10.1007/978-3-319-34027-2
ARCH. See autoregressive conditional
heteroskedasticity (ARCH)
Arrow-Debreu, 360
Asian options, 29, 289, 312–19
asset-linked FX option, 334
asset-or-nothing options, 294, 296
atom, 95, 117
autocorrelation, 184
autoregression, 184
autoregressive conditional
heteroskedasticity (ARCH), 184–7
average price options, 312, 313, 315
average strike options, 312
B
backwardation, 199
backward differences, 67, 69, 72
Barone Adesi, Whaley, 236–8, 475–8
barrier options, 289, 297–311
basket options, 327–32, 343
benign barrier, 310
485
486 Index
bet options, 293
better of options, 327
big figure, 204
binary options, 218, 292–8
binomial distribution, 28, 48
binomial model(s), vii, 24, 29–39,
43–64, 77, 91–3, 106–17, 265,
308, 358, 461, 467
bivariate normal distribution, 473
Bjerksund, Stensland, 238–9, 478
Black, 17, 18, 163, 218, 238
Black-Scholes, vii, viii, 15n1, 33, 43, 48,
51, 60–8, 73–7, 121, 131–3, 145,
154–77, 182, 189, 197–200,
205–19, 228–36, 245–88, 308,
326, 352–5, 451, 465–9
Black-Scholes deflator, 352–6
Black-Scholes formula, 34, 49, 173, 197,
212–18, 237, 274, 281, 284, 294,
320, 386, 451
Black-Scholes smoothing, 49–52, 54,
464
bond(s), 6, 10–18, 21, 30, 38, 83–4,
155, 161, 212–14, 230, 252, 307,
340–4, 356, 366, 452
bonus knock-out option, 304
Borel algebra, 103
Borel measurable, 103
Borel set(s), 103
box algebra, 138
Boyle, 239–40
Brownian motion, 33, 43, 97, 113,
128–33, 155–7, 182, 189–98,
249, 328, 337, 348
buck, 203
bull spread, 402–4
butterfly spread, 324
C 373–4
cable, 203
calendar spread, 323, 399, 438–41
capped option, 308, 340–2
caps, 15–18, 212, 342–4
cash-or-nothing digital options, 297
cash-or-nothing option(s), 289–94
Cauchy problem, 146
CBOE SKEW Index, 454–8
CBOE Volatility Index® (VIX® Index),
182, 452–9
central limit theorem, 9, 25–6, 28, 59,
76, 97, 130, 267
CFD. See contract for difference (CFD)
change of numeraire, 203
charm, 225, 226
chooser option, 289, 316–18
clearing, 1–7, 11, 161, 292, 366, 368,
451
cliquets, 319
coherent risk measures, 88–9
collar(s), 298
colour, 226, 332
commodity options, 209
complete, 35, 72, 96–8, 124, 226,
255–6, 266, 272–3, 297
complete market(s), 250, 265–7
complex chooser option, 316
compliance risk, 8
compound options, 324–6
conditional value at risk (CVaR), 85–8,
88n3
conditioned contract(s), 270, 271
conditioned expectation, 106–8
confidence level(s), 78, 85–8
consumption, 115
contango, 199
contingent claim(s), viii, 35–41, 70, 93,
164, 255, 272, 275–7, 337, 344,
351–61
continuous compounding, viii, 33, 73,
161, 353
contract for difference (CFD), 290–2,
control variance, 77
conversion ratio, 327
correlation function, 184, 473

correlation option(s), 327–8, 332
counterparty risk, 8, 10–11, 292
co-variance, 83, 84
covered call, 383, 429, 440–3
Cox-Ross-Rubenstein, 461
Crank-Nicholson, 69–70, 72, 467
credit risk, 3, 7–12, 78
cross, 203
currency-linked options, 333–9
currency options, 197–235, 289
currency-protected option, 334
currency risk, 8, 197, 334, 339
CUSIP, 6
CVaR. See conditional value at risk (CVaR)
D European option(s), 29, 48, 56, 77, 115,
deflators, 351–64
delayed-start options, 318
delta, 77, 82–4, 169, 173–4, 199–208,
219–25, 284, 294, 308–10, 379,
400, 440, 461, 467, 470
delta decay, 225
delta-gamma-hedging, 285–8
delta hedge, 77, 158, 161, 200, 204,
205, 219, 285, 294
delta-symmetric strike, 201
density function, 9, 105, 121–4, 165–7,
172, 193, 283
diffusion, 29, 96, 141, 171, 240–3,
245–88
diffusion process, viii, 28, 146, 147, 242,
245, 337
digital option(s), 216–18, 292–8, 308,
344–5
Dirac delta function, 169
distribution function, 98, 99, 236, 466
distribution measure, 98
dividend yield, 174, 214, 273–9
double no touch options, 300–1
Dow Jones Industrial Average, 182, 454
down-and-out calls, 307
down-and-out put option, 308
Index 487
drift, 29, 33, 96, 125, 128, 141, 148,
155, 212, 242, 247, 249–51, 262,
268
E
early exercise premium, 228, 236
equity price risk, 8
ES. See expected shortfall (ES)
Eurodollar, 199
European call option(s), 37, 54, 59, 73,
92, 111, 164, 171, 173–6, 188,
196, 214, 231, 283, 299, 342, 461
European digital FX option, 302
European knock-in option, 304
European knock-out option, 304
139, 158, 168, 180, 204, 212,
228–31, 236, 313, 322, 368
European option style, 207, 314–20,
334, 365, 453
European put option, 187
exchange option(s), 197, 327, 332–3
exercise region, 230
exotic options, viii, 35, 289–350
expectation value(s), viii, 23, 43, 100,
105–9, 141, 142, 147–51, 153,
164, 172, 190–2, 195, 314, 358
expected payoff, viii, 22, 247, 345,
351–4
expected shortfall (ES), 85–9
expected tail loss (ETL), 85
explicit finite difference method, 67–8
exploding spread option, 308
exponentially weighted moving average
model (EWMA), 187
exponential weighted VaR, 83
extensible option, 336–7
F
F-adapted, 96, 109, 142, 247
fair game, 23, 24, 37, 109, 246, 247
488 Index
fair value, 38, 358, 454
fear gauge, 454
fence, 401–6
Fenics, 205
Feynman–Kac, 131, 148–50, 195, 198,
256
filtration, 95–100, 109, 112, 116, 119,
233, 249–52, 261–7, 279
finer, 94, 99, 109, 119, 128
first in first out (FIFO), 369
fixed domestic strike options, 335
fixed exchange rate option, 334
F–measurable, 96
Fokker Planck, 29, 154
foreign exchange risk, 13
forward(s), 12–15, 27, 43, 66–77, 87,
135, 142, 153, 158–63, 184–7,
199–202, 212, 218, 273, 289,
300, 318–24, 333, 338, 348, 360,
367–9, 371–4, 382, 393,
398–401, 406–23, 430–6, 442–54
forward differences, 68, 142
forward options, 289, 318–24, 333
forward price, 43, 199, 367, 454
forward-start options, 318, 320
forward volatility, 322–4
future(s), viii, 6, 8–10, 13–16, 21–3, 34,
38, 43, 68, 69, 82, 135, 154,
161–3, 177, 182–6, 209, 215,
218, 230, 241, 265, 273, 278–80,
290, 316–21, 324, 333, 338, 340,
346, 358–62, 367–74, 380, 383,
387, 401, 406, 410, 416–19,
430–3, 438, 451–4, 459
F-Wiener process, 100
FX options, 197, 201–3, 209, 301, 334
G information generated by, 96
gain process, 275, 278–81
gamma (γ), 84, 220–1, 224, 285, 379,
461, 467
gap options, 297–8
GARCH, 183, 185–7
Garman Kohlhagen model, 197–235
Gaussian distributions, 348
geometric random walk, 159
Geske Johnson, 239
Girsanov, viii, 246–73, 281, 282, 353
Girsanov kernel, 248, 253, 257, 264,
282, 353
Girsanov theorem, 249, 253–9, 263,
269, 281
Girsanov transformation, 246–73
Greeks, vii, 57, 70, 173, 219, 224–8,
294, 308, 324, 379, 461–9
Green function, 170–1
H
hedge parameters, 57, 173, 219
hedging portfolio, 36
Herstatt risk, 12
heteroscedasticity, 184
Hopscotch, 70–2
I
implicit finite difference method, 68–9
implied volatility, 17, 33, 177, 178, 182,
183, 205–7, 320–2, 380, 451
independent, 26–8, 65, 97, 100, 106,
107, 128, 130, 136–9, 157, 175,
212, 231, 241, 253, 265, 266,
273, 320, 337, 343, 362, 447
independent σ-algebras, 106
index linked bond, 356
indicated, 102
indicator function, 102–5, 124, 153,
196
inflation linked claims, 355–6
information set, 23, 24
initial margin, 292, 366
integration schemas, 70
integration theory, 103–4

interest rate(s), viii, xi, 7–18, 21–3,
29–43, 57–9, 73–5, 83, 92, 98,
115, 128, 157–64, 174, 189,
195–223, 233, 247–56, 278–86,
325, 337–44, 352–467
interest rate risk, 8, 13, 251
International Swaps and Derivatives
Association (ISDA), 6, 7
intrinsic value, 56, 117, 215, 216, 296,
334, 376, 377
ISIN code, 5, 6
Itô formula, 140, 147–51, 195, 210, 247
Itô integral, 126, 135
Itô lemma, 125–33, 150, 156, 165
J marked to the market, 4
Jarrow-Rudd, 46, 47
Jensen’s unlikeness, 108
Jones, Dow, 182, 291, 454
jump diffusion, 240–3, 266
K Markov, 27, 97, 110–13, 241, 242
kappa, 222
Knock-out and knock-in options, 289,
298–311
Kolmogorov, 131, 153
kurtosis, 83, 122
L 233–5, 248, 254, 256–9, 266,
lambda, 224
least square, 177, 180–2
Lebesgue integrals, 103
legal risk, 8
Leisen–Reimer model, 48–54, 461–5
likelihood process, 252–9, 262–4
Lipschitz, 100
liquidity risk, 7
log-normal, 19, 44, 73, 121–5, 132,
167, 198, 212, 247, 266, 315,
323, 344
Index 489
log-normal distribution, 19, 44, 45, 73,
121, 133, 167
long butterfly, 436–9, 449
long call, 294, 309, 373, 379, 397,
415–20, 425, 459
long put, 318, 374, 379–89, 429, 459
long sloping synthetic forward, 416–19
long straddle, 378, 379, 443–6, 459
long strangle, 300, 444–9, 459
long synthetic forward, 415
Long-term capital management
(LTCM), 18
lookback options, 110, 289, 311
M
market indexes, 451–9
market price of risk, 40, 41, 249–52,
267, 352, 452
market price of volatility risk, 267, 353
market risk, 7, 8, 12–19, 78
marking-to-model, 14
Markov process, 110–13
martingale, vii, viii, 23–8, 31, 37, 62, 93,
97, 109, 115, 120, 135, 171, 188,
233–5, 245–8, 252–9, 266,
269–79, 281, 337, 345, 363
martingale approach, 171–3
martingale measure, 24, 31, 37, 93,
269–78, 281, 338, 345, 363
martingale representation, viii, 245, 255,
279
maximum likelihood, 261–5
maximum likelihood estimator, 187, 264
measurable, 9, 34, 95–103, 107–9,
119–20, 143, 255, 261, 271
measurable space, 95, 107, 261
model risk, 8, 13–20
mollification, 49
Monte Carlo, 11, 77, 138
490 Index
Monte-Carlo simulations, vii, 72–82,
138, 308, 315, 328, 344, 355–8
moving strike options, 319, 321
multi-asset options, 326–8, 335, 339
N pip(s), 204, 292, 299
Nasdaq, 182, 213, 291, 365–8, 454
natural filtration, 96, 252, 267
negative back-spread, 391–5
negative price spread, 382–7, 395–9
negative three-leg position, 394–6
negative time spread, 387–9
neutral time spread, 438–40, 459, 460
normal distribution, 10, 19, 25, 26,
43–7, 73, 79–83, 121, 133, 167,
187, 199, 236, 352–7, 455–8,
466, 473
normal random variable, 172, 352
no-touch currency option, 299
NYSE, 182, 454
O probability distribution(s), 26–8, 60–2,
ODE, 151, 191–5, 231, 280
OEX, 452–3
OMXS index, 367–8
one-touch currency option, 299
operational risk, 8
optimal exercise boundary, 230
options on commodities, 209
options on options, 289, 324–6
outcomes, 9, 21–7, 36–8, 82, 86–8,
92–4, 104, 107, 119, 124, 133,
139, 140, 246, 320, 325, 334, 348
outperformance option, 327
P quantity-adjusted option, 334
parity relations, 187–8
partial differential equation (PDE), vii,
29, 65–70, 145–68, 175, 198,
211, 228, 256, 273, 283
partition(s), 95–100
path-dependent options, 202, 298
pay-later option, 335–6
PDE. See partial differential equation (PDE)
Peizer–Pratt, 48, 465
perpetual American put, 231–3
P-martingale, 120
P–measurable, 99
Poisson distribution, 241
Poisson process, viii, 240–3
portfolio strategy(ies), 32, 254, 270–7
Portfolio VaR, 84–5
positive back spread, 411–14
positive price spread(s), 384–6, 401–7,
419, 427, 459
positive stair, 417–21
positive three leg, 424–31
positive time spread, 406–10
premium-included delta, 199
pre-settlement risk, 11
probability density function, 9, 122–4,
165, 172, 193
97, 119–21, 132, 165, 184, 193,
261
probability measure, 22–5, 31, 37, 93,
104, 105, 118–20, 196, 247–62,
269, 275, 353, 358, 473
probability space, 93–121, 252, 274, 358
protective put, 400–2, 459
put-call parity, 60
put-call symmetry, 202, 203
Put Hedge, 400
Q
quadratic integrable, 110, 271
quanto option, 339
quanto, quantos, 334–9, 344–6
quid, 203
Q-Wiener process, 249–55, 279–81

R sharpe ratio, 250, 356–7
Radon–Nikodym, 105, 118–21, 248,
268
rainbow option, 327–32, 336
random walk, 27–9, 96, 158, 159, 250,
251, 266
ranking the trades, 369
ratchet options, 321–22
ratchets, 319–22
ratio spread with call options, 412,
420–4
ratio-spread with put options, 389–92
ratio spread with underlyings, 410–11
reachable, 36, 255, 273, 277–8
rebate clause, 307
relative portfolio, 156
replicating portfolio, 36, 62, 188, 338
resetting options, 319
rho, 57, 223–8, 380, 451, 461, 467
Richardson extrapolation, 48–55, 63
RIC-name, 368
Riemann integral, 126
risk averse, 38, 39, 290
risk neutral drift of volatility, 212
risk-neutral probabilities, 24, 33–5, 40,
93, 119, 353
risk neutral valuation, 31, 38–43, 98,
351–62
risk-neutral valuation formula, 31
risk premium, 23, 41, 158, 249, 352–4
Roll, Geske, 236, 472
S 155, 210, 254, 276, 348, 353
sample space, 21, 22, 91–3, 104, 119
Scandies, 203
SDE. See stochastic differential equation
SEDOL. See Stock Exchange Daily
Official List
self financed, 156, 254–6, 270–2, 274–7
self-financing, 32, 271, 280
settlement, 1–7, 11, 12, 322, 367
Settlement risk, 12
Index 491
short butterfly, 448–51
short call, 371–4
short straddle, 431–5
short strangle, 433–7
Siegel’s Exchange Rate Paradox, 259–61
σ-algebra, 94, 108
σ-algebra generated, 96
simple, 14, 21, 27–9, 34, 36, 39, 61, 79,
83, 102–5, 125, 133, 142, 146,
160–1, 171, 180, 185, 189–92,
214–15, 230, 235, 251, 262–6,
292, 313–19, 340, 352, 358
skewness, 83, 122, 206, 457
soft call provision, 307
Standard & Poor’s (S&P), 6, 182, 183,
291, 332, 452–5, 457, 458
splitting index S(E), 95
spread betting, 291
spread option, 308, 327
SPX, 452, 453
standard deviation, 9, 10, 74, 81–3, 139,
155, 177, 249, 349–52, 454–7,
473
standard error, 75–6
state prices, 358–64
stochastic differential equation (SDE),
100, 127, 146–51, 165, 210, 243,
349
stochastic integral, 135, 142, 147
stochastic integration, 133–43
stochastic process, 23, 27, 33, 43, 73, 96,
97, 107–9, 125, 131, 140, 146,
stochastic variable, 30, 36, 43, 91, 96, 99,
105–7, 109, 116, 212, 255, 270
stochastic volatility, 16, 20, 72, 210–12,
250, 267
Stock Exchange Daily Official List
(SEDOL), 6
stopping times, 113–17, 234–5
straddle, 201, 300, 316–18, 324, 378,
379, 431–5, 443–7
492 Index
strangle, 206, 300, 324, 433–7, 444–6
structured products, 340, 344
sub martingale, 24, 109, 235
super martingale, 24, 109, 115
SWIFT, 2, 7
Synthetic Call, 400–2
synthetic contracts, 372–4
Synthetic sold put, 440–3
T 380, 461, 467
tau, 223
Taylor series expansion, 243
theta, 221–6, 295, 309, 379, 461, 467
Tian, 47
Tigori, 47
time value, 50, 215, 220, 229–31, 296,
376–9, 383, 386, 399, 403, 442
touch options, 308
Tower property, 101
transition probabilities, 152–3
trinomial tree, 67, 239–40
20/20 Option, 332
2X, 99
U 136, 140, 147, 155, 190, 210,
Uhlenback process, 348–50
up-and-out puts, 307–8
V WPKN, 6
Value-at-Risk (VaR), 13, 18–20, 27,
78–89
value process, value processes, 30, 32, 35,
62, 92, 113, 115, 155, 156, 255,
270, 272, 280
Vanna, 225
VaR. See Value-at-Risk (VaR)
variance, ix, 10, 26–9, 43, 47, 73, 76–8,
81–4, 87, 97, 101, 121–3,
128–30, 133, 137–9, 155, 172,
183, 184, 186, 198, 207, 329,
352, 356
variance reduction, 76–7
variation margin, 4, 292
vega, 57, 222–4, 227, 295, 309, 322–4,
VIX futures, 452, 454
VIX volatility index, 182
VKN number, 5
volatility, viii, 8, 33, 125, 148, 247, 300,
353, 376
volatility heat map, 454, 456
volatility surface, 177–82, 206
volga, 224
VVIX, 454, 455
W
weather derivative, viii, 346–50
Whaley, R. E., 236, 472
Wiener process, 33, 96–100, 113, 129,
245, 249, 253–8, 262–81, 348
window barrier knock-in option, 305
window barrier knock-out option, 305
WKN, 6
Y
yard, 203