Method and system for pricing financial derivatives

Abstract

A method for providing a bid price and / or an offer price of an option relating to an underlying asset, the method including the steps of receiving first input data corresponding to a plurality of parameters defining the option, receiving second input data corresponding to a plurality of current market conditions relating to the underlying value, computing a corrected theoretical value (CTV) of the option based on the first and second input data, computing a bid / offer spread of the option based on the first and input data, computing a bid price and / or an offer price of the option based on the corrected TV and the bid / offer spread, and providing an output corresponding to the bid price and / or the offer price of said option.

Description

FIELD OF THE INVENTION[0001]The invention relates generally to financial instruments and, more specifically, to methods and systems for pricing financial derivatives and for providing automatic trading capabilities.BACKGROUND OF THE INVENTION[0002]Pricing financial instruments, e.g., financial derivatives, is a complex art requiring substantial expertise and experience. Trading financial instruments, such as options, involves a sophisticated process of pricing typically performed by a trader.[0003]The term “option” in the context of the present application is defined broadly as any financial instrument having option-like properties, e.g., any financial derivative including an option or an option-like component. This category of financial instruments may include any type of option or option-like financial instrument, relating to some underlying asset. Assets as used in this application include anything of value; tangible or non-tangible, financial or non-financial. For example, as us...

AI Technical Summary

Benefits of technology

"The present invention provides a method and system for accurately calculating the bid and offer prices of options on underlying assets, such as stocks, bonds, and currencies. The method is automated and does not require human intervention. The system uses a model that takes into account various factors and risks associated with the option, such as forward rates, interest rates, and market conditions. The method can be used in real-time and allows for online transactions. The invention also provides a way to adapt the model to different types of options and markets. The technical effects of the invention include improved accuracy in option pricing, increased liquidity in the derivatives market, and improved credit lines for corporations and funds."

Problems solved by technology

Pricing financial instruments, e.g., financial derivatives, is a complex art requiring substantial expertise and experience.

If the spot (i.e., current market) price is lower than the strike price, the holder may choose not to exercise the call option and lose only the cost of the option itself.

As is known in the art, the right to exercise an American option prior to expiration makes American options more expensive than corresponding European options.

The much less common American Vanilla options are traded exclusively OTC, and are difficult to price.

The method of the '517 patent ignores data that may affect the price of the option, except for the current price of the underlying asset and, thus, this method can lead to serious errors, for example, an absurd result of a negative option price.

Clearly, this method does not emulate the way American style Vanilla options are priced in real markets.

Unfortunately, methods based on historical data alone are not relevant for simulating financial markets, even for the purpose of theoretical valuation.

Furthermore, due to the peculiar profile of some exotic options, there may be significant transaction costs associated with re-hedging some of the risk factors.

However, the markets trade based on a volatility that reflects the market expectations of the standard deviation in the future.

For equity options, as another example, the volatility plot tends to be monotonous.

It should be noted that a Vanilla option is always more expensive than a corresponding exotic option.

In general, the more difficult it is to manage the risk of an option, the wider is the bid / offer spread for that option.

One dilemma commonly faced by traders is how wide the bid / offer spread should be.

Providing too wide a spread reduces the ability to compete in the options market and is considered unprofessional, yet too narrow a spread may result in losses to the trader.

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