The Quality Option and Timing Option in Futures Contracts

Authors

  • PHELIM P. BOYLE

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    • School of Accountancy, University of Waterloo. The author thanks Gord Willmot for very helpful suggestions. He is also grateful to Eric Kirzner, George Blazenko, Len Eckel, Tony Atkinson, Bill Scott, Duane Kennedy, and Keith Sharp for useful comments. He is grateful to Mark Rubinstein for helpful suggestions and acknowledges the useful comments of an anonymous referee and the editor of this Journal. An earlier version of this paper was presented at the Research Seminar of the Canadian International Futures Conference in Toronto. Research support from the Canadian Securities Institute, the Centre for Accounting Research and Education at the University of Waterloo, and the Natural Sciences and Engineering Research Council of Canada is gratefully acknowledged.


ABSTRACT

Often futures contracts contain quality options whereby the short position has the choice of delivering one of an acceptable set of assets. We explore the implications of the quality option on the futures price. We develop a method for pricing the quality option for the general case of n deliverable assets and provide numerical illustrations of its significance. Even when the asset prices are very highly correlated, this option can have nontrivial value, especially when there is a large number of deliverable assets. We analyze the impact of the timing option and its interaction with the quality option. A procedure is developed for valuing the timing option in the presence of the quality option, and some numerical estimates are obtained.

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