On the valuation of multiple reset options: integral equation approach

TL;DR

This paper develops an integral equation approach to price multiple reset options, characterizing optimal reset boundaries and offering a new derivative instrument suited for volatile cryptocurrencies.

Contribution

It introduces a novel integral equation framework for pricing multiple reset options, reducing the problem to single optimal stopping problems and deriving reset premiums.

Findings

Optimal reset boundaries are characterized by nonlinear integral equations.

The approach provides explicit reset premium representations.

Multiple reset options are proposed as attractive cryptocurrency derivatives.

Abstract

In this paper, we study a pricing problem of the multiple reset put option, which allows the holder to reset several times a current strike price to obtain an at-the-money European put option. We formulate the pricing problem as a multiple optimal stopping problem, then reduce it to a sequence of single optimal stopping problems and study the associated free-boundary problems. We solve this sequence of problems by induction in the number of remaining reset rights and exploit probabilistic arguments such as local time-space calculus on curves. As a result, we characterize each optimal reset boundary as the unique solution to a nonlinear integral equation and derive the reset premium representations for the option prices. We propose that the multiple reset options can be used as cryptocurrency derivatives and an attractive alternative to standard European options due to the extreme volatility of underlying cryptocurrencies.