Innovations: Valuing S&P 500 Bear Market Warrants with a Periodic Reset

Abstract

When the stock market has experienced a long period of rising prices, many investors begin to worry that it is about to fall. They may buy put options, only to kick themselves as a further advance in prices takes their protective puts far out of the money. One solution is a bear market warrant whose strike price is reset after three months to be at the money if the market has risen above the original strike. These securities are like puts, but with several important differences in pricing and in their Greek letter sensitivities. The reset feature also affects the American early exercise premium. In this article, Gray and Whaley explain the properties of these interesting warrants, provide valuation equations, and examine their pricing in the market vis-a-vis regular options.

JEL Classification: G13, G11