M. Suresh Sundaresan

The Valuation of Options on Futures Contracts

Coauthor(s): Krishna Ramaswamy.

Rational restrictions are derived for the values of American options on futures contracts. For these options, the optimal policy, in general, involves premature exercise. A model is developed for valuing options on futures contracts in a constant interest rate setting. Despite the fact that premature exercise may be optimal, the value of this American feature appears to be small and a European formula due to Black serves as a useful approximation. Finally, a model is developed to value these options in a world with stochastic interest rates. It is shown that the pricing errors caused by ignoring the location of the interest rate (relative to its long-run mean) range from -5.

Source: Journal of Finance
Exact Citation:
Ramaswamy, Krishna, and M. Suresh Sundaresan. "The Valuation of Options on Futures Contracts." Journal of Finance 40, no. 5 (December 1985): 1319-40.
Volume: 40
Number: 5
Pages: 1319-40
Date: 12 1985