Financial option insurance

TL;DR

This paper introduces a novel financial product called option insurance that protects investors from option-related risks by insuring premiums, using a new three-entity framework and a mathematical model to balance protection and profitability.

Contribution

It proposes a new financial option insurance product integrating insurance principles with options, supported by a mathematical model for risk management and profit optimization.

Findings

The model effectively insures options of different moneyness.

It reduces potential losses for option insurers.

The framework addresses market loopholes and enhances stability.

Abstract

The option is a financial derivative, which is regularly employed in reducing the risk of its underlying securities. However, investing in option is still risky. Such risk becomes much severer for speculators who utilize option as a means of leverage to increase their potential returns. In order to mitigate risk on their positions, the rudimentary concept of financial option insurance is introduced into practice. Two starkly-dissimilar concepts of insurance and financial option are integrated into the formation of financial option insurance. The proposed financial product insures investors option premiums when misfortune befalls on them. As a trade-off, they are likely to sacrifice a limited portion of their potential profits. The loopholes of prevailing financial market are addressed and the void is filled by introducing a stable three-entity framework. Moreover, a specifically designed mathematical model is proposed. It consists of two portions: the business strategy of matching and a verification-and-modification process. The proposed model enables the option investors with calls and puts of different moneyness to be protected by the issued option insurance. Meanwhile, it minimizes the exposure of option insurers position to any potential losses.