A Method Of Pricing Freight Options And Its Application

Along with the advances of world economic activities, the financial derivative market has grown so varied and powerful that it's an essential part of our economic system. Options, as a specific kind of derivative product, are widely considered as an ideal tool both to avoid risks, and to gain profit in the market. Such versatility and its flexible nature fare well in almost every industry, making options one very active type of derivative.On the other side, oceanic shipping has also developed rapidly during the process. This business has long rooted in the global economics by its highly affordable but yet massive capacity, but the risks are always huge in comparison to other industries. Contributing factors comes from both the nature and human society, varying from climate and ocean current to specific demand and economic health, all being unpredictable. So freight derivatives were created in recent years after the boom of derivative markets, in attempt to meet the needs of both the vessel owners and charterers.Freight Option is one type of those derivatives, while it is still quite new to many, it has showed great potential. Thanks to the nature of high risks, it does not only attract traditional clients, such as previously mentioned vessel owners and charterers, but also big investors. Its usage has gone beyond the sole risk control. Needless to say, extensive research is very much needed.One critical part of the research is the pricing problem. In fact, the pricing problem is critical to every single type of option. But freight options are different from traditional options such as stock options. In most cases they deploy the method of arithmetic average Asian options, which belong to the exotic option family. This makes it unlikely to use currently widely applied techniques, such as Black-Scholes and CRR. So In this essay, an applicable method is introduced, attempting to give a practical solution to the pricing of freight options.At the very beginning Chapter 1, the background of freight options, its pricing and the current status of pricing are briefly discussed. Chapter 2 overviewed financial derivative markets and freight derivative markets, providing a market perspective on the importance of this issue. In Chapter 3, we highlight some very important concepts for our following mathematical model. An explicit model is introduced in Chapter 4, using a framework that converts the arithmetic average Asian option closer to the well-known European option. Also in this chapter, the pricing formulas for both call and put are given. The following Chapter 5 focuses on improving the estimation of volatility, a must for the pricing process. Finally, Chapter 6 uses field numbers to demonstrate the complete pricing process. In the end, we give a general analysis the problem of our presented model, and also look into several other possibilities of pricing in the future.