Title: A binomial model for pricing US-style average options with reset features

Authors: Massimo Costabile, Ivar Massabo, Emilio Russo

Addresses: Department of Business Administration, University of Calabria, Ponte Bucci cubo 3 C, 87036, Rende (CS), Italy. ' Department of Business Administration, University of Calabria, Ponte Bucci cubo 3 C, 87036, Rende (CS), Italy. ' Department of Business Administration, University of Calabria, Ponte Bucci cubo 3 C, 87036, Rende (CS), Italy

Abstract: We develop a pricing algorithm for US-style period-average reset options written on an underlying asset which evolves in a Cox-Ross-Rubinstein (CRR) framework. The averaging feature of such an option on the reset period makes the price valuation problem computationally unfeasible because the arithmetic average is not recombining on a CRR tree. To overcome this obstacle, we associate to each node of the lattice belonging to the reset period a set of representative averages chosen among all the effective arithmetic averages attained at that node. On the remaining time to maturity, a US period-average reset option becomes a US standard one and the Barone Adesi-Whaley approximation is used to compute an option value in correspondence to each representative average lain at the end of the reset period.

Keywords: financial derivatives; reset options; binomial algorithms; CRR model; pricing algorithms; Cox-Ross-Rubinstein; price valuation; option values.

DOI: 10.1504/IJFMD.2010.034238

International Journal of Financial Markets and Derivatives, 2010 Vol.1 No.3, pp.258 - 273

Published online: 30 Jul 2010 *

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