"The Valuation of Options on Futures Contracts"
Journal of Finance,
Volume: 40 | Issue: 5 | Pages: 1319-40
Publication type: Journal article
Research Archive Topic: Capital Markets and Investments
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.
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