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arXiv · 1404.6792

Leveraged {ETF} implied volatilities from {ETF} dynamics

Tim Leung·Matthew Lorig·Andrea Pascucci
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Abstract

The growth of the exhange-traded fund (ETF) industry has given rise to the trading of options written on ETFs and their leveraged counterparts {(LETFs)}. We study the relationship between the ETF and LETF implied volatility surfaces when the underlying ETF is modeled by a general class of local-stochastic volatility models. A closed-form approximation for prices is derived for European-style options whose payoff depends on the terminal value of the ETF and/or LETF. Rigorous error bounds for this pricing approximation are established. A closed-form approximation for implied volatilities is also derived. We also discuss a scaling procedure for comparing implied volatilities across leverage ratios. The implied volatility expansions and scalings are tested in three well-known settings: CEV, Heston and SABR.

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Tim Leung, Matthew Lorig, Andrea Pascucci. 2015-04-15. Leveraged {ETF} implied volatilities from {ETF} dynamics. https://arxiv.org/abs/1404.6792

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