basketbyju

Price European basket options using Nengjiu Ju approximation model

Syntax

Price = basketbyju(RateSpec,BasketStockSpec,OptSpec,Strike,Settle,Maturity)

Description

Price = basketbyju(RateSpec,BasketStockSpec,OptSpec,Strike,Settle,Maturity) prices European basket options using the Nengjiu Ju approximation model.

Examples

Price European Basket Options Using Nengjiu Ju Approximation Model

Find a European call basket option of two stocks. Assume that the stocks are currently trading at $10 and $11.50 with annual volatilities of 20% and 25%, respectively. The basket contains one unit of the first stock and one unit of the second stock. The correlation between the assets is 30%. On January 1, 2009, an investor wants to buy a 1-year call option with a strike price of $21.50. The current annualized, continuously compounded interest rate is 5%. Use this data to compute the price of the call basket option with the Nengjiu Ju approximation model.

Settle = datetime(2009,1,1);
Maturity  = datetime(2010,1,1);

% Define the RateSpec.
Rate = 0.05;
Compounding = -1;
RateSpec = intenvset('ValuationDate', Settle, 'StartDates', ...
Settle, 'EndDates', Maturity, 'Rates', Rate, 'Compounding', Compounding);

% Define the Correlation matrix. Correlation matrices are symmetric and
% have ones along the main diagonal.
Corr = [1 0.30; 0.30 1];

% Define the BasketStockSpec.
AssetPrice =  [10;11.50]; 
Volatility = [0.2;0.25];
Quantity = [1;1];
BasketStockSpec = basketstockspec(Volatility, AssetPrice, Quantity, Corr);

% Compute the price of the call basket option.
OptSpec = {'call'};
Strike = 21.5;
PriceCorr30 = basketbyju(RateSpec, BasketStockSpec, OptSpec, Strike, Settle, Maturity)

PriceCorr30 = 2.1221

Compute the price of the basket instrument for these two stocks with a correlation of 60%. Then compare this cost to the total cost of buying two individual call options.

Corr = [1 0.60; 0.60 1];

% Define the new BasketStockSpec.
BasketStockSpec = basketstockspec(Volatility, AssetPrice, Quantity, Corr);

% Compute the price of the call basket option with Correlation = -0.60
PriceCorr60 = basketbyju(RateSpec, BasketStockSpec, OptSpec, Strike, Settle, Maturity)

PriceCorr60 = 2.2757

The following table summarizes the sensitivity of the option to correlation changes. In general, the premium of the basket option decreases with lower correlation and increases with higher correlation.

Compute the cost of two vanilla 1-year call options using the Black-Scholes (BLS) model on the individual assets:

StockSpec = stockspec(Volatility, AssetPrice);
StrikeVanilla= [10;11.5];

PriceVanillaOption = optstockbybls(RateSpec, StockSpec, Settle, Maturity,...
OptSpec, StrikeVanilla)

PriceVanillaOption = 2×1

    1.0451
    1.4186

Find the total cost of buying two individual call options.

sum(PriceVanillaOption) 

ans = 2.4637

The total cost of purchasing two individual call options is $2.4637, compared to the maximum cost of the basket option of $2.27 with a correlation of 60%.

Input Arguments

RateSpec — Interest-rate term structure

structure

Interest-rate term structure (annualized and continuously compounded), specified by the RateSpec obtained from intenvset. For information on the interest-rate specification, see intenvset.

Data Types: struct

BasketStockSpec — BasketStock specification

structure

BasketStock specification, specified using basketstockspec.

Data Types: struct

OptSpec — Definition of option

character vector with values 'call' or 'put' | cell array of character vectors with values 'call' or 'put'

Definition of the option as 'call' or 'put', specified as a character vector or a 2-by-1 cell array of character vectors.

Data Types: char | cell

Strike — Option strike price value

scalar numeric | vector

Option strike price value, specified as one of the following:

• For a European or Bermuda option, Strike is a scalar (European) or 1-by-NSTRIKES (Bermuda) vector of strike prices.

• For an American option, Strike is a scalar vector of the strike price.

Data Types: double

Settle — Settlement or trade date

datetime scalar | string scalar | date character vector

Settlement or trade date for the basket option, specified as a scalar datetime, string, or date character vector.

To support existing code, basketbyju also accepts serial date numbers as inputs, but they are not recommended.

Maturity — Maturity date

datetime scalar | string scalar | date character vector

Maturity date for the basket option, specified as a scalar datetime, string, or date character vector.

To support existing code, basketbyju also accepts serial date numbers as inputs, but they are not recommended.

Output Arguments

Price — Expected price for basket option

numeric

Expected price for basket option, returned as a numeric.

More About

Basket Option

A basket option is an option on a portfolio of several underlying equity assets.

Payout for a basket option depends on the cumulative performance of the collection of the individual assets. A basket option tends to be cheaper than the corresponding portfolio of plain vanilla options for these reasons:

• If the basket components correlate negatively, movements in the value of one component neutralize opposite movements of another component. Unless all the components correlate perfectly, the basket option is cheaper than a series of individual options on each of the assets in the basket.

• A basket option minimizes transaction costs because an investor has to purchase only one option instead of several individual options.

For more information, see Basket Option.

References

[1] Nengjiu Ju. “Pricing Asian and Basket Options Via Taylor Expansion.” Journal of Computational Finance. Vol. 5, 2002.

Version History

Introduced in R2009b

R2022b: Serial date numbers not recommended

Although basketbyju supports serial date numbers, datetime values are recommended instead. The datetime data type provides flexible date and time formats, storage out to nanosecond precision, and properties to account for time zones and daylight saving time.

To convert serial date numbers or text to datetime values, use the datetime function. For example:

t = datetime(738427.656845093,"ConvertFrom","datenum");
y = year(t)

y =

        2021

There are no plans to remove support for serial date number inputs.