Cutting edge introduction: Funding holes in Black-Scholes

When pricing options, traders tend to avoid complexities such as funding costs and benefits, and haircuts on stocks used to delta-hedge options, but they do so at the risk of serious mispricing, warns one HSBC quant. Nazneen Sherif introduces this month’s technical articles

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In common with other derivatives, trading options involves funding costs. However, the impact of funding is often ignored entirely or only partially modelled into options prices – an omission that could cause trades to be significantly mispriced, according to Wujiang Lou, a director in global fixed-income trading at HSBC.

In this month's first technical, Funding in option pricing: the Black-Scholes framework extended, Lou offers an extension to the Black-Scholes pricing formula, which takes

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