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Perpetual American strangle options (PASOs) offer investors a method for minimizing risk during highly volatile market scenarios by allowing them to buy or sell options at any date without an expiration date. In a new study, researchers investigated the pricing of PASOs under a stochastic volatility model with fast mean reversion which better captures real markets compared to traditional models.

Options are a financial instrument that gives the holder the right to buy and sell an underlying asset, at a predetermined price, on or before a specified date. For example, European-style options allow the buyer to exercise this right at its maturity date, while American-style options can be exercised at any time up to and including the expiration date. These are generally traded in public financial markets, such as stock exchanges.

With the increasing complexity of markets, a wide range of products have emerged, including strangle options. A strangle option is an investment strategy that combines call and put options, both with the same expiration date but different strike prices. This strategy is typically used by investors who anticipate a large fluctuation in the market in either direction, as it helps minimize potential losses.

PASOs take this further by allowing the holder to exercise the options at any time, without an expiration date, providing considerable benefits. Consequently, PASOs have been the focus of considerable research. However, despite such studies, the pricing of PASOs and their early exercise boundaries have not yet been studied using a stochastic volatility (SV) model, which more accurately captures real market behavior compared to the Black-Scholes model.

Addressing this gap, a team of researchers led by Associate Professor Ji-Hun Yoon from Pusan National University, Korea developed a pricing formula for PASOs under an SV model with fast mean reversion. Their findings were made available online on July 27, 2024 in Mathematics and Computers in Simulation.

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