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

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