Cash-settlement options containing a wild-card exercise feature and Contingent Value Rights: Two applications of contingent claims valuation

Nicholas Valerio, University of Pennsylvania


This paper presents two cases of contingent claims valuation using the risk-neutral technique. The first case recognizes that American-style call options on the S&P100 index are frequently exercised prior to their expiration dates. A "wild-card" feature of the S&P100 contract is exploited to explain this phenomenon. A theoretical model that values a class of options containing wild-card features is derived, and then evaluated using two different numerical techniques. The results indicate that the wild-card feature enhances the values of these options beyond that of their American-style counterparts. Early exercise of the index call is rational under these circumstances, even without dividends. When dividend payments are introduced, the value of the wild-card feature becomes even greater. The optimal exercise policy and comparative statics for these options are also investigated. The second case examines Contingent Value Rights, which are securities with finite lives that have been issued to expedite the mergers of firms. This financial instrument is a derivative security whose underlying asset is the equity of the newly-created company. If the price of the underlying shares is below a prearranged target level at expiry, then the holder of a CVR receives from its issuer in cash the difference, up to a present maximum, of the target level and the share price. Moreover, at the expiry the issuer has the right to extend the CVR's expiration to a preestablished second date in which case both the target level and the maximum payment are increased. The risk-neutral approach to contingent claims analysis is augmented to derive a valuation formula for these securities. Theoretical values are then calculated and compared to historical prices for the two exchange-traded CVRs. A portfolio strategy to profit from the differences of the values and prices is devised and tested. The comparative statics and the optimal extension policy are investigated as well.

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Recommended Citation

Valerio, Nicholas, "Cash-settlement options containing a wild-card exercise feature and Contingent Value Rights: Two applications of contingent claims valuation" (1992). Dissertations available from ProQuest. AAI9227781.