1) How does one value option on the spread between two indexes ? Does one model the spread in itself using a single factor model or does one need to build a multi-factor model to account for the behavior of individual indexes?What are the pros and cons of each?
2) How does one price an option using th forward price curve? Does he simply compute the price change between two points on the curve as a measure of volaitlity and feed it into Black-Schoeles(for simplicity we assume that its a log normal distribution and that we can use BS)?
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1) SIngle factor models dont
1) SIngle factor models dont handle correlation properly. so you will use a two or more factor model. I have 10+factor models that i use.
2) Regular black scholes but with the correct forward point should be close enough for government work. for atm stuff at least.