Pricing and calibration of the futures options market: A unified approximation

Abstract

The constant elasticity of variance (CEV) model is widely used in modeling commodity futures prices, but it may not perform well in calibrating corresponding futures options. We consider two variations of the CEV model, that is, CEV with jumps and CEV with regime switching, and compare their performance in calibrating the Chinese futures options market. In particular, we propose a unified framework for pricing American futures options by combining the continuous‐time Markov chain approximation and the dynamic programming method. Results show that the inverse leverage effect in the soybean meal options market can be better described by the CEV regime‐switching model.