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Risks

A Quantum Algorithm for Pricing Asian Options on Valuation Trees

Mark-Oliver Wolf, Roman Horsky, Jonas Koppe

Published Nov 22, 2022• 2 citations
Publisher

Abstract

We develop a novel quantum algorithm for approximating the price of a discrete floating-strike Asian option based on an underlying valuation tree. The paths of the tree are encoded in bit-representation into a qubit register, where quantum state preparation is used to load the corresponding distribution onto the states. We implement the expectation value of the option pricing formula as a composition of the price probabilities, the payout and an indicator function, mapping their respective values to amplitudes of additional qubits. Thus, the underlying no longer has to be discretized into the same bit values for different times, resulting in smaller quantum circuits. The algorithm may be used with quantum amplitude estimation, enabling a quadratic speed-up over classical Monte Carlo methods.

DOI
10.3390/risks10120221

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We develop a novel quantum algorithm for approximating the price of a discrete floating-strike Asian option based on an underlying valuation tree. The paths of the tree are encoded in bit-representation into a qubit register, where quantum state preparation is used to load the corresponding distribution onto the states. We implement the expectation value of the option pricing formula as a composition of the price probabilities, the payout and an indicator function, mapping their respective values to amplitudes of additional qubits. Thus, the underlying no longer has to be discretized into the same bit values for different times, resulting in smaller quantum circuits. The algorithm may be used with quantum amplitude estimation, enabling a quadratic speed-up over classical Monte Carlo methods.
The valuation of American options and the determination of optimal stopping times remain central challenges in option pricing theory and derivatives valuation. Classical approaches to multidimensional problems rely on the dynamic programming principle, which is notoriously difficult to parallelize. Moreover, the need to store continuation values for all simulated paths in each dynamic programming step imposes severe memory constraints on classical computers, limiting the scale of feasible simulations. Quantum computing offers a promising way to address these limitations. In this paper, the authors introduce a novel algorithm for pricing American options on quantum hardware. To date, only one method has been proposed for this purpose. The authors' approach combines the Quantum Binomial Tree with Quantum Machine Learning to enable direct valuation of American options on a quantum computer. By incorporating quantum amplitude estimation, it could achieve a quadratic speed-up over classical Monte Carlo methods. Furthermore, it exploits the exponential growth of the quantum state vector, overcoming the memory bottlenecks that restrict classical approaches.
Options are financial instruments whose payoffs are determined by the value of an underlying asset. These underlying assets are typically stocks, interest rates, or exchange rates, but can also include commodities such as energy or agricultural products. Options serve diverse purposes, including hedging against price volatility and speculating on market movements. Additionally, they play a critical role in assessing certain positions on the balance sheets of insurance companies, particularly in the context of solvency capital requirement calculations. As an option’s payoff lies in the future and is stochastic in nature, finding a fair price today is a non-trivial task. The focus of this work is finding quantum algorithms for calculating these prices and compare them to algorithms designed for classical computers. This work follows two different directions on how to improve on classical methods for option pricing. The first direction is improving on Monte-Carlo (MC) methods and the second one is adapting Fourier based pricing algorithms. The Amplitude Estimation (AE) algorithm promises a quadratic speedup compared to classical MC. This fact makes this algorithm an interesting candidate for improvements by quantum algorithms. It was shown in the literature, that simple options with very crude discretization of the underlying stochastic models, can be implemented on a quantum device and evaluated with AE. One big challenge is the efficient implementation of the option’s payoff profile. To solve this problem colleagues and I have introduced a multi-objective genetic algorithm to automatically find well performing and efficient circuits to implement the payoff of non-path-dependent European options on one or more underlyings. Another strategy for pricing options is based on the fact, that in many models the characteristic function of the underlying is numerically more tractable than its distribution function. There are methods that make use of this fact and the performance of the Fast Fourier Transform (FFT) to efficiently calculate prices for European call options for many strikes in one go. The quantum version of the FFT, the Quantum Fourier Transform (QFT), is in some sense, even faster than its classical counterpart. We have adapted the existing classical method to make use of QFT, to benefit from its performance. Finally, the different strategies are benchmarked and compared regarding their accuracy, their potential for scaling and their adaptability to different styles of derivatives and models. The result of this comparison are requirements on the quantum hardware for the methods to be viable as well as use cases where each method has its benefits over the others.
Efficiently generating or loading probability distributions on quantum computers is a foundational task in Quantum Monte Carlo methods. While the quantum amplitude estimation algorithm offers a quadratic speed-up over classical Monte Carlo techniques, this advantage can be negated if the probability distribution is not effectively loaded. Moreover, any practical approach must be flexible enough to accommodate a wide range of market models�a requirement unmet by existing methods. In this paper, we propose a novel and efficient approach for loading probability distributions tailored to derivative pricing. The proposed method, the Quantum Binomial Tree, serves as a quantum analog of the classical Binomial Tree model. This approach enables exponential scaling in the number of Monte Carlo paths, while retaining an overall quadratic speed-up compared to classical algorithms. We demonstrate how the Quantum Binomial Tree framework can load prominent financial models�including the local volatility model, and the Heston model onto a quantum computer. Furthermore, this paper includes a detailed implementation for option pricing under time-dependent volatility, as well as numerical results.
We consider the problem of pricing discretely monitored Asian options over TTT monitoring points where the underlying asset is modeled by a geometric Brownian motion. We provide two quantum algorithms with complexity poly-logarithmic in TTT and polynomial in 1/ε1/ε1/ε, where εεε is the additive approximation error. Our algorithms are obtained respectively by using an O(log⁡T)O(\log T)O(logT)-qubit semi-digital quantum encoding of the Brownian motion that allows for exponentiation of the stochastic process and by analyzing classical Monte Carlo algorithms inspired by the semi-digital encodings. The best quantum algorithm obtained using this approach has complexity O~(1/ε3)\widetilde{O}(1/ε^{3})O(1/ε3) where the O~\widetilde{O}O suppresses factors poly-logarithmic in TTT and 1/ε1/ε1/ε. The methods proposed in this work generalize to pricing options where the underlying asset price is modeled by a smooth function of a sub-Gaussian process and the payoff is dependent on the weighted time-average of the underlying asset price.
We present a methodology to price options and portfolios of options on a gate-based quantum computer using amplitude estimation, an algorithm which provides a quadratic speedup compared to classical Monte Carlo methods. The options that we cover include vanilla options, multi-asset options and path-dependent options such as barrier options. We put an emphasis on the implementation of the quantum circuits required to build the input states and operators needed by amplitude estimation to price the different option types. Additionally, we show simulation results to highlight how the circuits that we implement price the different option contracts. Finally, we examine the performance of option pricing circuits on quantum hardware using the IBM Q Tokyo quantum device. We employ a simple, yet effective, error mitigation scheme that allows us to significantly reduce the errors arising from noisy two-qubit gates.
In this work, we present a quantum algorithm designed to solve the differential equation used in the pricing of Asian options, in the framework of the Black-Scholes model. Our approach modifies an existing quantum pre-conditioning method (different from classical methods) for the problem of Asian option pricing such that we remove the dependence on the original condition number of discretized differential equation (system of linear equations). This was possible with new fast-forwardable discretizations of the first and second derivatives with respect to the underlying asset value ratio (value over average). We determine that these discretizations handle well kinks in the initial/terminal conditions. We also introduce a new circuit construction for the discretized time-derivative operator with Dirichlet boundary conditions which avoids the oracle workspace needed for the general sparse matrix implementation. Here, we also devised a new method probability integral estimation from which we extract the solution, achieving O~(polylog(1/ε))\tilde{O}({\rm polylog}\left(1/ε)\right)O~(polylog(1/ε)), which is an exponential improvement over other quantum methods when it comes to solution information extraction from the solution state.