Bund options implied

G

Grant

There was zero response from the Options forum on this. I'll try here.

Which is the standard model to determine implieds on Bund options?

Being US-style exercise, Black or Black-Scholes are inappropriate.

All things considered, the Hull and White model, utilising trinomial trees, seems the favourite but also appears somewhat complex to my non-mathematical mind.

Any suggestions?

Thank you.

Grant
 
Trade4success,

“since when doesn't black scholes "work" for us style options?”

The price of the (underlying) bond must equal its face value at maturity, referred to as “pull-to-par”. This removes the uncertainty (variability or volatility) of its price in the future/at maturity (I presume this doesn’t apply in the intervening period in regard to a possible change in the term structure). Contrast this with stocks or indexes – the greater the time ahead, the greater the uncertainty.

Interest rates (the key component of bond valuation) are generally mean reverting – if high, will tend towards lower, and vice versa. Stock prices are not mean-reverting

The early exercise possibility means the bond price must be accounted for at all times, as per binomial model.

I stand to be corrected.

This is pretty well covered in Hull’s, Options, Futures and Other Derivative Securities (2nd edition).

Quite1,

Thank you for the reference. I’ll check it out.

Grant.
 
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