Forecasting Out-Of-The-Money Call Option Strike Prices for Bull Option Spreading Strategies

Abstract

A bull spread strategy which takes advantage of the leverage and response characteristics of options is constructed by purchasing a near-or at-the-money option, followed by selling a higher strike price out-of-the-money option. the difficulty with this strategy is choosing the optimal out-of-the-money option strike price. for this research, a model is developed utilizing Generalized Autoregressive Conditional Heteroskedasticity (GARCH) and Value-at-Risk (VaR) techniques for the risk management of the aforementioned option trading strategy. This model will be compared against a similar model using an Auto-Regressive Moving Average (ARMA) and VaR. the GARCH model proposed in this paper is an iterative compounding process where the next day's forecasted price will be included in the model to forecast the following day's price and volatility measure. the forecasted price and volatility will be used to measure the VaR. the VaR technique will be used to choose the optimum strike price for the given risk and time frame for the strategy. the approach followed in this paper will allow the option trader to manage the risk in selling an option that generates the highest payoff while still having a chance of becoming in-the-money for the option buyer.

Department(s)

Engineering Management and Systems Engineering

International Standard Book Number (ISBN)

978-160423713-9

Document Type

Article - Conference proceedings

Document Version

Citation

File Type

text

Language(s)

English

Rights

© 2024 American Society for Engineering Management , All rights reserved.

Publication Date

01 Dec 2005

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