Pricing options on the cryptocurrency futures contracts

TL;DR

This paper evaluates various advanced option pricing models for cryptocurrency futures, finding models with jumps and stochastic volatility outperform traditional methods in capturing market dynamics.

Contribution

It compares the effectiveness of multiple sophisticated models in pricing cryptocurrency options, highlighting the importance of jumps and stochastic volatility.

Findings

Kou and Bates models have the lowest pricing errors.

Black-Scholes model performs poorly with high errors.

Different models excel for Bitcoin and Ether options.

Abstract

The cryptocurrency options market is notable for its high volatility and lower liquidity compared to traditional markets. These characteristics introduce significant challenges to traditional option pricing methodologies. Addressing these complexities requires advanced models that can effectively capture the dynamics of the market. We explore which option pricing models are most effective in valuing cryptocurrency options. Specifically, we calibrate and evaluate the performance of the Black-Scholes, Merton Jump Diffusion, Variance Gamma, Kou, Heston, and Bates models. Our analysis focuses on pricing vanilla options on futures contracts for Bitcoin (BTC) and Ether (ETH). We find that the Black-Scholes model exhibits the highest pricing errors. In contrast, the Kou and Bates models achieve the lowest errors, with the Kou model performing the best for the BTC options and the Bates model for ETH options. The results highlight the importance of incorporating jumps and stochastic volatility into pricing models to better reflect the behavior of these assets.