How Do Traditional Models for Option Valuation Perform When Applied to Cryptocurrency Options?

Sammanfattning: The market for cryptocurrencies has been known to be volatile with an asymmetrical return distribution where occasional extreme returns appear. In later years options have been introduced on the asset; but due to the characteristics of cryptocurrency returns, researchers have found it troublesome to value these options. Primarily, research has been advocating for advanced pricing models and suggested the elemental Black-Scholes model to perform inferior to these models. The market for cryptocurrency options have grown rapidly, which puts into question whether the Black-Scholes model in today’s more liquid market can reliably predict option prices? If not, can the Heston model, which allows for stochastic volatility, be a better fit? This study is, to my knowledge, the first to evaluate the Heston model on options with Ethereum as underlying asset; wherefore it contributes to research by incorporating a broader analysis of the model’s performance on cryptocurrency options. Based on real market prices I calibrate and evaluate the two models on puts and calls with Bitcoin and Ethereum as underlying assets. My findings indicate that the Black-Scholes model outperforms the Heston model for all the four considered option types and that the models are better suited for valuing options on Ethereum than Bitcoin.