PINN

Physics-Informed Neural Networks (PINNs) for American-Style Option Pricing

Overview

A Physics-Informed Neural Network (PINN) is a neural architecture that embeds known physical or financial laws directly into its training process.
Instead of learning purely from data, the PINN minimizes a composite loss function that enforces the governing partial differential equation (PDE) — in this case, the Black–Scholes equation — as a soft constraint.

This approach allows the network to:

• Learn the structure of option prices under no-arbitrage conditions,
• Generalize better than purely data-driven models, and
• Provide continuous, differentiable pricing surfaces across strike, time, and volatility domains.

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The Black–Scholes PDE

For a European-style call option with price $V(S, t)$, spot price $S$, time $t$, constant risk-free rate $r$, and volatility $\sigma$, the Black–Scholes equation is:

$$\frac{\partial V}{\partial t} + \frac{1}{2} \sigma^2 S^2 \frac{\partial^2 V}{\partial S^2} + r S \frac{\partial V}{\partial S} - r V = 0$$

subject to the terminal condition at maturity $T$:

$$V(S, T) = \max(S - K, 0)$$

for strike price $K$.

The PINN learns a function $\hat{V}_\theta(S, t, \sigma, K, r)$ whose derivatives (computed via automatic differentiation) are constrained to satisfy this PDE throughout the training domain.

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Loss Function Design

The total training loss combines three key components:

$$\mathcal{L} = \lambda_{\text{PDE}} \cdot \mathcal{L}_{\text{PDE}} + \lambda_{\text{terminal}} \cdot \mathcal{L}_{\text{terminal}} + \lambda_{\text{data}} \cdot \mathcal{L}_{\text{data}}$$

where:

• PDE residual loss enforces the Black–Scholes differential constraint:

  \mathcal{L}_{\text{PDE}} = \mathbb{E}\left[\left(
  V_t + \tfrac{1}{2}\sigma^2 S^2 V_{SS} + r S V_S - r V
  \right)^2\right]
  

• Terminal loss enforces the payoff condition $V(S, T) = \max(S-K, 0)$

• Data loss (optional) fits observed market or synthetic prices

Training is performed using stochastic gradient descent (e.g., Adam), with all spatial and temporal derivatives computed via PyTorch’s autograd.

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American Options Extension

For American-style options, early exercise introduces a free boundary condition:

$$V(S, t) \geq \max(S - K, 0)$$

and the PDE becomes an inequality-constrained problem (a complementarity formulation):

$$\min\left( \frac{\partial V}{\partial t} + \frac{1}{2} \sigma^2 S^2 \frac{\partial^2 V}{\partial S^2} + r S \frac{\partial V}{\partial S} - r V,\; V - (S - K) \right) = 0$$

In the PINN framework, this condition is typically handled by:

• Adding a penalty term that enforces $V \geq \text{payoff}$,
• Or training two subnetworks (one for the continuation region, one for the exercise region),
• Or using a ReLU barrier to ensure nonnegative exercise premium.

Support for this is currently in development.

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Visualization and Validation

After training, we visualize the PINN's predictions against analytic Black–Scholes solutions (for European-style options) under a constant volatility assumption:

plt.plot(S_grid, V_true, label="Black–Scholes (analytic)")
plt.plot(S_grid, V_pred, '--', label="PINN prediction")
plt.xlabel("Underlying Price S")
plt.ylabel("Option Price V(S, t)")
plt.legend()
plt.grid(True)

European-Style Options (PINN) — Explanation of the Code

This section describes how the repository implements a Physics-Informed Neural Network (PINN) for European-style option pricing, and explains the key pieces of the reference implementation (model, losses, training loop, and evaluation).

1 — What the PINN learns

The model approximates the option pricing function $V(S, t; K, r, \sigma)$ where:

• S is the underlying asset price (spot),
• t is the current time (measured in years),
• K is the option strike,
• r is the risk-free rate,
• σ is volatility (constant or per-sample).

We train a neural network V̂_θ that takes (scaled) inputs and outputs the option price.

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2 — Governing PDE (enforced in the loss)

The Black–Scholes PDE (used for the PDE residual term) is rendered using the math fenced block below:

$$\frac{\partial V}{\partial t} + \tfrac{1}{2}\sigma^{2} S^{2} \frac{\partial^{2} V}{\partial S^{2}} + r S \frac{\partial V}{\partial S} - r V = 0$$

The PINN minimizes the mean-square of this PDE residual over randomly sampled collocation points (S, t) in the training domain.

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3 — Loss components

The overall loss is a weighted sum of three terms:

• PDE residual loss
  Mean squared PDE residual across collocation points:

  L_pde = mean( (V_t + 0.5 * sigma^2 * S^2 * V_SS + r*S*V_S - r*V)^2 )
  

• Terminal (payoff) loss
  Enforce the terminal condition at maturity T:

  $$V(S, T) = \max(S - K, 0)$$

  Practically:

  L_term = mean( (V(S, T) - max(S - K, 0))**2 )

• Data loss (optional)
  Fit observed market prices (or synthetic BS prices) at sampled (S, t):

  L_data = mean( (V_pred - market_price)**2 )

Final loss:

Loss = λ_pde * L_pde + λ_term * L_term + λ_data * L_data

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4 — Key implementation details (what the code does)

Below are the important functions and design choices from the reference implementation.

Model

A fully connected feed-forward network that accepts scaled inputs (S_scaled, t_scaled, sigma_scaled) and outputs the scalar price:

class PINN(nn.Module):
    def __init__(self, input_dim=3, width=64, depth=3):
        super().__init__()
        layers = []
        layers.append(nn.Linear(input_dim, width))
        layers.append(nn.Tanh())
        for _ in range(depth - 1):
            layers.append(nn.Linear(width, width))
            layers.append(nn.Tanh())
        layers.append(nn.Linear(width, 1))
        self.net = nn.Sequential(*layers)

    def forward(self, S, t, sigma):
        x = torch.cat([S, t, sigma], dim=1)  # (N, 3)
        return self.net(x)                   # (N, 1)

Note: scaling (S/K and t/T) is applied before passing inputs to the network. Scaling stabilizes training.

PDE residual (autograd)

We compute derivatives using torch.autograd.grad. The residual function returns the PDE residual for a batch of (S,t):

def pde_residual(model, S, t, sigma, r):
    S_req = S.clone().detach().requires_grad_(True)
    t_req = t.clone().detach().requires_grad_(True)
    sigma_in = sigma.clone().detach()

    V = model(S_req_scaled, t_req_scaled, sigma_scaled)  # model expects scaled inputs

    V_S = torch.autograd.grad(V, S_req, grad_outputs=torch.ones_like(V), create_graph=True)[0]
    V_t = torch.autograd.grad(V, t_req, grad_outputs=torch.ones_like(V), create_graph=True)[0]
    V_SS = torch.autograd.grad(V_S, S_req, grad_outputs=torch.ones_like(V_S), create_graph=True)[0]

    residual = V_t + 0.5 * (sigma_in ** 2) * (S_req ** 2) * V_SS + r * S_req * V_S - r * V
    return residual

In practice, the code wraps the model so that raw physical variables S and t are scaled internally before being passed to the neural net.

Terminal condition loss

Evaluate the network at t = T and penalize deviation from the intrinsic payoff:

def terminal_loss(model, S_terminal, K, r, sigma, T):
    t_T = torch.full_like(S_terminal, T)
    V_pred_T = model(S_terminal_scaled, t_T_scaled, sigma_scaled)
    payoff = torch.maximum(S_terminal - K, torch.zeros_like(S_terminal))
    return torch.mean( (V_pred_T - payoff)**2 )

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5 — Training loop (high-level skeleton)

The training loop alternates the computation of the three loss terms and backpropagates the weighted sum:

for epoch in range(n_epochs):
    optimizer.zero_grad()

    # collocation samples (S_coll, t_coll)
    residual = pde_residual(wrapped_model, S_coll, t_coll, sigma_coll, r)
    L_pde = torch.mean(residual**2)

    # terminal loss
    L_term = terminal_loss(wrapped_model_T, S_terminal, K_term, r, sigma_term, T_maturity)

    # optional data loss
    V_pred_data = model(S_data_scaled, t_data_scaled, sigma_data_scaled)
    L_data = torch.mean( (V_pred_data - price_data)**2 )

    loss = pde_weight * L_pde + term_weight * L_term + data_weight * L_data
    loss.backward()
    optimizer.step()

Practical notes:

• Use a relatively large term_weight (terminal loss) to ensure the network respects the payoff.
• Train first with Adam, optionally fine-tune with LBFGS for better convergence.
• Sample collocation points broadly across the S and t domain (e.g., S ∈ [0, 3K] and t ∈ [0, T]).

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6 — Evaluation & visualization

After training:

• Evaluate V̂ on a grid S_grid × t_grid and compare to analytic Black–Scholes results (when σ is constant) to validate correctness.
• Typical plots:
  • V_PINN(S, t=0) vs. analytic V_BS(S, t=0).
  • Training history (total loss and components).
  • Residual heatmap |PDE_residual(S,t)|.

Example plotting code snippet:

# Evaluate on a grid at t = 0
S_grid = torch.linspace(0.01, 2*K_val, 300).view(-1,1).to(device)
t_zero = torch.zeros_like(S_grid).to(device)
# scale inputs and run model...
V_pred = model(S_grid_scaled, t_zero_scaled, sigma_grid_scaled).cpu().numpy().flatten()

# analytic Black–Scholes
V_true = bs_price_call_torch(S_grid.cpu(), K_grid.cpu(), t_zero.cpu(), T_maturity, r_val, sigma_const).cpu().numpy().flatten()

plt.plot(S_grid.cpu().numpy(), V_true, label='Black–Scholes (analytic)')
plt.plot(S_grid.cpu().numpy(), V_pred, '--', label='PINN prediction')
plt.xlabel('Underlying price S')
plt.ylabel('Option price V(S,t=0)')
plt.legend(); plt.grid(True)

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7 — How to plug in real market data

To use actual option-market data:

1. Build tensors of (S, t, K, sigma, market_price) where:
   • S = current spot (or historical spot when price snapshot was taken)
   • t = current time (or the time corresponding to the market price), or time-to-maturity
   • sigma = implied volatility (optional — can be used as input) or leave as constant
   • market_price = mid-price (or other observed price)
2. Replace the mock S_data, t_data, K_data, sigma_data, price_data used in the demo with your actual tensors (all shaped (N,1)).
3. Keep the PDE residual and terminal loss components — they act as regularizers that enforce no-arbitrage structure.

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8 — Tips & troubleshooting

• Scaling: Always scale S and t before passing to the network (e.g. S_scaled = S/K, t_scaled = t/T). This makes training stable.
• Small maturities: For extremely small time-to-maturity, guard against numerical issues in the analytic price and in tau = T - t (clamp with eps).
• Weights: Tune λ_pde, λ_term, and λ_data. If the network reproduces market prices but violates the PDE, increase λ_pde.
• Local volatility: To learn a σ(S,t), replace sigma as an input with a small subnetwork sigma_net(S_scaled, t_scaled) that outputs a positive volatility (e.g. via softplus). Train both subnets jointly with the PDE residual.