PRICING AND HEDGING AMERICAN OPTIONS ANALYTICALLY: A PERTURBATION METHOD

Abstract

This paper studies the critical stock price of American options with continuous dividend yield. We solve the integral equation and derive a new analytical formula in a series form for the critical stock price. American options can be priced and hedged analytically with the help of our critical-stock-price formula. Numerical tests show that our formula gives very accurate prices. With the error well controlled, our formula is now ready for traders to use in pricing and hedging the S&P 100 index options and for the Chicago Board Options Exchange to use in computing the VXO volatility index.

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