Center for Industrial Mathematics and Statistics » REU 2018 – Pricing TYVIX Options Using a Risk-Neutralized Historical Distribution

Rajita Chandak

Monte Fischer

Jonathan Ladd

Anthony Sisti

Overview

Industrial Sponsor: Dr. Hari Krishnan - Doherty Advisors, LLC.

Faculty Advisors: Marcel Blais, Stephan Sturm

Volatility indexes provide a measure of unpredictability in the future behavior of financial markets. Two such indexes, the VIX and TYVIX, were created by the Chicago Board Options Exchange (CBOE) to quantify expected volatility in the US stock and bond markets, respectively. Over the last 15 years, volatility derivatives have gained popularity among investors for hedging risk and diversifying investments. While options are not yet publicly traded on the TYVIX, there is interest in finding fair prices for TYVIX options that are traded over-the-counter (OTC). We first develop a pricing model for exchange-traded VIX options that may be validated using current market prices, and then extend the model to price TYVIX options. Building on Zou and Derman's methodology in "Strike-Adjusted Spread,'' the historical distribution of returns is transformed to satisfy risk neutrality at a minimum loss of information. Using this risk-neutralized return distribution, the fair market price for an option may be predicted by calculating its expected future payoff.