## Options On Options Compound Options

i Definitions We will consider an option the compound option on an underlying option. Both the compound and the underlying options can be either put or call options, so that we have four options to consider in all. Half the battle in pricing these of compound underlying option option options is simply getting the notation straight, and this can be summarized as follows UNDERLYING OPTIONS Cu St, X, t Pu St, X, t Stock price at time t and volatility Value at time t of an underlying call put...

## Binary Digital Options

i Recall the simple derivation of the Black Scholes formula which was given in Section 5.2. In its simplest form, this may be written F St max 0, St - X dST F St St - X dST where F ST is the lognormal probability distribution of ST. The two terms in this equation will now be interpreted separately, rather than together as they were before Reiner and Rubinstein, 1991b . ii Cash or Nothing Option Bet In the term fX F ST X dST, the factor X appears in two un- related roles as a constant...

## Forward Contracts

i A forward contract is a contract to buy some security or commodity for a predetermined price, at some time in the future the purchase price remains fixed, whatever happens to the price of the security before maturity. Clearly, the market or spot price and the forward price will tend to converge Figure 1.3 as the maturity date is approached a one-day forward price will be pretty close to the spot price. In the last section we used the example of a forward currency contract this is the...

## Applications

i European Call Jarrow-Rudd Method u d-1 econsider the tree shown in Figure 7.4. From the specification of the option and equation 7.6 , the following parameters can be calculated Using these u and d factors, we can start filling in the stock prices on the tree shown just above each node . The intermediate values of St are not really necessary for a European option, since the option payoff only depends on the stock price at maturity however, they are shown for ease of understanding. The payoff...

## Combinations Of Options

This is a book on option theory and many how to books are available giving very full descriptions of trading strategies using combinations of options. There is no point repeating all that stuff here. However, even the most theoretical reader needs a knowledge of how the more common combinations work, and why they are used also, some useful intuitive pointers to the nature of time values are examined, before being more rigorously developed in later chapters. Most of the comments will be confined...