Options with Constant Underlying Elasticity in Strikes |
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Authors: | Email author" target="_blank">Lloyd?P?BlenmanEmail author Steven?P?Clark |
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Institution: | (1) Department of Finance and Business Law, University of North Carolina at Charlotte, USA |
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Abstract: | Closed-form solutions are derived and interpreted for European options, with stochastic strike prices, that maintain constant
elasticity of the strike with respect to the price of the underlying asset. We refer to such options as CUES. CUES preserve the relative shares of exercise price risk for both the buyer and writer of the option, regardless of whether
the price of the underlying asset moves up or down. The relevance of the CUES concept is established through applications
in two distinct fields. First, it is established that CUES-like options are embedded in private equity investments. This concept
is then used in a novel application to determine the equity share of a private company corresponding to a given level of investment.
Secondly, the advantages that CUES would provide over traditional executive stock option grants are considered and it is shown
that CUES can provide enhanced incentive-alignment without increasing options expense to the company.
JEL Classification: G130 |
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Keywords: | exotic options exercise price uncertainty nonlinear payoff options |
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