Chappuis Halder Cie Options Pricer Documentation

International Business Solutions Advisors
Global Research & Analytics Dpt.

Valuation & Pricing Solutions

By David REGO -Paris Office-
Supported by Benoit GENEST -London Office- and Ziad Fares -Paris Office-

Free Pricer Content
Detail of Generic Closed Formulas Solutions

April, 2013


Chappuis Halder & Cie
GENESIS
PHILOSOPHY
The department of Global Research &
Analytic (GRA) is a team of passionate
people. One unifying criteria in the GRA
remains the dominant quantitative topics,
including the risk modeling part.
As such, each member works regularly on
topics likely to be of interest to the
financial community. The results of this
work are always freely downloadable and
fully shared with anyone interested.
Because we consider risk modeling as a
hobby, we try to share ideas or researches
that we found useful within our day to day
practice.
INTRODUCTION
The following document is in response to
repeated requests from various players in
the market and asking for quick access to
a conventional financial pricing library.
Formerly available on the internet, it is
now more difficult to find on the web.
Our approach is to bring up to date all the
work done by Espen Gaarder HAUG
1
and
to complete it with a summary document
to assist the reader. This document is
based on his great work. Moreover, we
would like to thank him for his significant
contribution in options pricing field and to
share it with the financial community.
In an initiative to promote knowledge and
expertise sharing, Chappuis Halder & Cie
decided to put this Options Pricer on free
access. It contains a charts generator and
the detail sheets of each type of options.

1
The pricing formulas and codes are from his book: The
complete guide to option pricing formulas, edited by McGraw-
Hill (second edition).
WARNING OF NO PROPERTY
This document and all its contents,
including texts, formulas, charts and any
other material, are not the property of
CH&Cie.
WARNING OF NO
RESPONSIBILITY
The information, formulas and codes
contained in this document are merely
informative.
There is no guarantee of any kind, express
or implied, about the completeness or
accuracy of the information provided via
this document. Any reliance you place on
the descriptions, mathematical formulas
or related graphs is therefore strictly at
your own risk.

TABLE OF CONTENTS
1.A. The Generalized Black & Scholes Formula ....................................................................................... 1
1.B. The generalized Black and scholes options sensitivities .................................................................. 2
2. European option on a stock with cash dividends ................................................................................ 8
3. The Black-Scholes model adjusted for trading day volatility (French) ................................................ 9
4. The mertons Jump Diffusion Model option pricing.......................................................................... 10
5. American Calls on stocks with known dividends ............................................................................... 11
6.A. American approximations: The Barone-Adesi and Whaley approximation .................................. 12
6.B. American approximations: The Bjerksund and Stensland approximation ..................................... 14
7. The Miltersen and Schwartz commodity option model .................................................................... 16
8. Executive stock options ..................................................................................................................... 18
9. Forward start options ........................................................................................................................ 19
10. Time switch options ........................................................................................................................ 20
11.A. Simple chooser options ................................................................................................................ 21
11.B. Complex chooser optionS ............................................................................................................ 22
12. Options on options .......................................................................................................................... 24
13. Writer extendible options ............................................................................................................... 26
14. Two assets correlation options ....................................................................................................... 28
15. Option to exchange one asset for another ..................................................................................... 29
16. Exchange options on exchange options .......................................................................................... 31
17. Options on the maximum or the minimum of two risky assets ...................................................... 34
18. Spread option approximation ......................................................................................................... 36
19. Floating strike lookback options ...................................................................................................... 38
20. Fixed strike lookback options .......................................................................................................... 40
21. Partial-Time Floating-Strike Lookback Options ............................................................................... 42
22. Partial-Time Fixed-Strike Lookback Options .................................................................................... 44
23. Extreme-spread options .................................................................................................................. 46
24. Standard barrier options ................................................................................................................. 48
25. Double barrier options .................................................................................................................... 52
26. Partial-time single asset barrier options ......................................................................................... 55
27. Two asset barrier options ................................................................................................................ 60
28. Partial time two asset barrier options ............................................................................................. 63
29. Look-barrier options ........................................................................................................................ 66
30. Soft-barrier options ......................................................................................................................... 68

31. Gap options ..................................................................................................................................... 70
32. Cash-or-nothing options .................................................................................................................. 71
33. Two asset cash-or-nothing options ................................................................................................. 72
34. Asset-or-nothing options ................................................................................................................. 74
35. Supershare options ......................................................................................................................... 75
36. Binary barrier options...................................................................................................................... 76
37. Asian Options 1: Geometric average rate options .......................................................................... 86
38. Asian Options 2: The Turnbull and Wakeman arithmetic average approximation ......................... 87
39. Asian Options 3: Levy's arithmetic average approximation ............................................................ 88
40. Foreign equity options struck in domestic currency (Value in domestic currency) ........................ 90
41. Fixed exchange rate foreign equity options - Quantos (Value in domestic currency) .................... 92
42. Equity linked foreign exchange options (Value in domestic currency) ........................................... 94
43. Takeover foreign exchange options ................................................................................................ 96
44. European swaptions in the Black-76 model .................................................................................... 97
45. The Vasicek model for european options on zero coupon bonds .................................................. 98


1

1.A. THE GENERALIZED BLACK & SCHOLES FORMULA
DESCRIPTION
This function allows to price plain vanilla European call and put options,
using the Generalized Black and Scholes formula.
MATHEMATICAL FORMULA
The Generalized Black & Scholes formulas for a call and put are
( )
1 2
. ( ) . ( )
b r T rT
Call S e CND d X e CND d

=
( )
2 1
. ( ) . ( )
rT b r T
Put X e CND d S e CND d

=
Where d
1
and d
2
are defined by the following formulas
2
1
ln
2
S
b T
X
d
T
o
o
| | | |
+ +
| |
\ . \ .
= 2 1
d d T o =
And
S = Forward Asset price
X = Strike price
r = Risk-free rate
T = Time to maturity (Years)
b = Cost of carry
= Volatility
CND(x)= The Cumulative Normal Distribution Function

PAYOFFS
The payoffs of this model can be represented as follows (for 2 positions:
buying a call in the left side and buying a put in the right side)

NB: "Payoffs" Charts represent prices seven days before expiry, not payoffs formulas
INSTRUMENT PRICE
The prices of this model according to the price of the underlying asset
and the time to maturity can be represented as follows (for 2 positions:


2

1.B. THE GENERALIZED BLACK AND SCHOLES OPTIONS SENSITIVITIES
DELTA
DESCRIPTION
The parameter Delta, notedo , is the sensitivity of the plain vanilla options
price to the underlying asset price.
( ).
1
. ( )
b r T
Call
e CND d o

=

( ).
1
.( ( ) 1)
b r T
Put
e CND d o

=

With:
2
1
log .
2
.
S
b T
X
d
T
o
o
| | | |
+ +
| |
\ . \ .
=
and
2 1
d d T o =

DELTA VALUE NEAR MATURITY IN DEPENDENCE OF THE SPOT PRICE
Buying a call position is in the left side while buying a put position is in the
right side.

DELTA VALUE EVOLUTION IN DEPENDENCE OF BOTH THE SPOT PRICE AND THE
TIME TO MATURITY
right side.


3

GAMMA
DESCRIPTION
The parameter Gamma, noted , is the sensitivity of the plain vanilla options
delta to the underlying asset price. It measures the acceleration and
curvature of the options price evolution.
( ).
1
. ( )
.
b r T
option
e CND d
S T
=

With:
2
1
log .
2
.
S
b T
X
d
T
o
o
| | | |
+ +
| |
\ . \ .
=
and
2 1
d d T o =

GAMMA VALUE NEAR MATURITY IN DEPENDENCE OF THE SPOT PRICE
The gamma is the same for a call or a put.

GAMMA VALUE EVOLUTION IN DEPENDENCE OF BOTH THE SPOT PRICE AND
THE TIME TO MATURITY
The gamma is the same for a call or a put.

0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
0
0
0
0
0
0
0
0
0
0
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

4

VEGA
DESCRIPTION
The parameter Vega, notedv , is the sensitivity of the plain vanilla options
price to the underlying asset volatility.
( ).
1
. . ( ).
b r T
option
vega S e CND d T
=

With:
2
1
log .
2
.
S
b T
X
d
T
o
o
| | | |
+ +
| |
\ . \ .
=
and
2 1
d d T o =

VEGA VALUE NEAR MATURITY IN DEPENDENCE OF THE SPOT PRICE
The vega is the same for a call or a put.

VEGA VALUE EVOLUTION IN DEPENDENCE OF BOTH THE SPOT PRICE AND THE
TIME TO MATURITY
The vega is the same for a call or a put.

0
1
2
3
4
5
6
7
8
9
10
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
5
10
15
20
25
30
35
40
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

5

THETA
DESCRIPTION
The parameter Theta, notedu , is the sensitivity of the plain vanilla options
price to the time to maturity.
( ).
1
( ). .
1 2
. ( ).
( ).
2
. . ( ) . . . ( )
b r T
Call
b r T r T
S e CND d
b r
T
S e CND d r X e CND d
o
u

( ).
( ). 1
1
.
2
. ( ).
( ). . . ( )
2
. . . ( )
b r T
b r T
Put
r T
S e CND d
b r S e CND d
T
r X e CND d
o
u

= +
+

With:
2
1
log .
2
.
S
b T
X
d
T
o
o
| | | |
+ +
| |
\ . \ .
=
and
2 1
d d T o =

THETA VALUE NEAR MATURITY IN DEPENDENCE OF THE SPOT PRICE
right side.

THETA VALUE EVOLUTION IN DEPENDENCE OF BOTH THE SPOT PRICE AND THE
TIME TO MATURITY
right side.

-50
-45
-40
-35
-30
-25
-20
-15
-10
-5
0
5
50 60 70 80 90 100 110 120 130 140 150
Spot
-50
-45
-40
-35
-30
-25
-20
-15
-10
-5
0
5
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
-50
-45
-40
-35
-30
-25
-20
-15
-10
-5
0
5
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
-50
-45
-40
-35
-30
-25
-20
-15
-10
-5
0
5
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

6

RHO
DESCRIPTION
The parameter Rho, noted , is the sensitivity of the plain vanilla options
price to the interest rate.
2

b 0: . . . ( )
.Call (S,X,T,r,b, )
rT
call
call Generalized BS
if T X e CND d
else T
= =
=

2

b 0: . . . ( )
.Put (S,X,T,r,b, )
rT
put
put Generalized BS
if T X e CND d
else T
= =
=

With:
2
1
log .
2
.
S
b T
X
d
T
o
o
| | | |
+ +
| |
\ . \ .
=
and
2 1
d d T o =

RHO VALUE NEAR MATURITY IN DEPENDENCE OF THE SPOT PRICE
right side.

RHO VALUE EVOLUTION IN DEPENDENCE OF BOTH THE SPOT PRICE AND THE
TIME TO MATURITY
right side.

0
0,2
0,4
0,6
0,8
1
1,2
1,4
1,6
1,8
2
2,2
50 60 70 80 90 100 110 120 130 140 150
Spot
-2
-1,8
-1,6
-1,4
-1,2
-1
-0,8
-0,6
-0,4
-0,2
0
0,2
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
80
90
100
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
-100
-90
-80
-70
-60
-50
-40
-30
-20
-10
0
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

7

COST OF CARRY
DESCRIPTION
The parameter Rho, notedb , is the sensitivity of the plain vanilla options
price to the cost of carry.
( ).
1
. . . ( )
b r T
Call
b T S e CND d
=
( ).
1
. . . ( )
b r T
Put
b T S e CND d
=

With:
2
1
log .
2
.
S
b T
X
d
T
o
o
| | | |
+ +
| |
\ . \ .
=
and
2 1
d d T o =

CARRY SENSITIVITY VALUE NEAR MATURITY IN DEPENDENCE OF THE SPOT
PRICE
right side.

CARRY SENSITIVITY VALUE EVOLUTION IN DEPENDENCE OF BOTH THE SPOT
PRICE AND THE TIME TO MATURITY
right side.

0
0,2
0,4
0,6
0,8
1
1,2
1,4
1,6
1,8
2
2,2
2,4
2,6
2,8
3
50 60 70 80 90 100 110 120 130 140 150
Spot
-3
-2,8
-2,6
-2,4
-2,2
-2
-1,8
-1,6
-1,4
-1,2
-1
-0,8
-0,6
-0,4
-0,2
0
0,2
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
-60
-50
-40
-30
-20
-10
0
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

8

2. EUROPEAN OPTION ON A STOCK WITH CASH DIVIDENDS
DESCRIPTION
This function allows to price plain vanilla European call and put options with
cash dividend, using the original Black Scholes formula. Although simple, this
approach can lead to significant mispricing and arbitrage opportunities. In
particular, it will underprice options where the dividend is close to the
option's expiration date.
1 2
. ( ) . ( )
rT
Call S CND d X e CND d
=

2 1
. ( ) . ( )
rT
Put X e CND d S CND d
=

2
1 2 1
ln
2
Where ;
S
r T
X
d d d T
T
o
o
o
| | | |
+ +
| |
\ . \ .
= =

3 1 2
1 2 3
. . .
rt rt rt
Dividends
With S stock price NPV s D e D e D e

= =
Where
- s is the Stock price
-
1 2
, D D and
3
D are dividends for
1 2
t , t and
3
t .
- X = Strike price
- r = Risk-free rate
- T = Time to maturity (Years)
- = Volatility
- CND(x)= The Cumulative Normal Distribution Function (CND)
PAYOFFS


INSTRUMENT PRICE

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

9

3. THE BLACK-SCHOLES MODEL ADJUSTED FOR TRADING DAY VOLATILITY (FRENCH)
DESCRIPTION
This function allows to price plain vanilla European call and put options,
using the adjusted Generalized Black and Scholes formula. This adjustment
was done by French in 1984 to take into consideration that the volatility is
usually higher on trading days than on non-trading days. If trading days to
maturity are equals to calendar days to maturity, the output theoretical price
would be the same as the one generated by the Generalized Black Scholes
formula.
( )
1 2
( )
2 1
. . ( ) . ( )
. ( ) . . ( )
b r T rT
rT b r T
Call S e CND d X e CND d
Put X e CND d S e CND d

=
=
Where :
2
1
ln .
2
S
bT t
X
d
t
o
o
| |
+ +
|
\ .
= and
2 1
d d t o =
With:
- S = Stock Price
- X = Strike Price
- r = Risk-Free Rate
- t = Trading time= Trading days until maturity / Trading days per year
- T = Calendar Time = Calendar days until maturity / Calendar days per
year
- = Standard Deviation

PAYOFFS

INSTRUMENT PRICE

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

10

4. THE MERTONS JUMP DIFFUSION MODEL OPTION PRICING
DESCRIPTION
This Model allows to price plain vanilla European call and put options, using
the Mertons Jump Diffusion formula. This alternative model supposes a non-
correlated Brownian motion and jumps.
0
( )
( ; ; ; ; )
!
T i
i i
i
e T
Call Call S X T r
i
o

=
=

0
( )
( ; ; ; ; )
!
T i
i i
i
e T
Put Put S X T r
i
o

=
=

With :
2 2
i
i
z
T
o o
| |
= +
|
\ .
;
2
o
o
=
and
2 2
z o o =
NB:
i
Call and
i
Put are calculated with the Generalized Black Scholes
Function.

With :
- S = Stock Price
- X = Strike Price
- T = Calendar Time (time to Expiration on years)

PAYOFFS

INSTRUMENT PRICE

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

11

5. AMERICAN CALLS ON STOCKS WITH KNOWN DIVIDENDS
DESCRIPTION
This Model allows to price American Calls on stocks with known dividends,
using the Roll-Geske-Whaley approximation formula. We consider here that
the stock is paying a single discrete dividend yield. The method can be
extended to a multiple dividends.
1 1 1
2 2 2
2
1 2 1
2
1
( ). ( ) ( ). , ;
. . , ; ( ). ( )
ln
2
With ;
ln
2

rt rt
rT rt
rt
rt
c
t
Call S De CND b S De M a b
T
t
X e M a b X D e CND b
T
S De
r T
X
a a a T
T
S De
r T
S
b
T
o
o
o
o
o

| |
= + |
|
\ .
| |
|
|
\ .
| | | |
+ +
| |
\ . \ .
= =
| | | |
+ +
| |
\ . \ .
=
2 1
; b b T o =

With:
- S = Stock Price; X = Strike Price; = Standard Deviation; r = Risk-Free Rate;
D
= Cash Div.; T = Time to option expiration; t = time to dividend payout
- CND(x)= The Cumulative Normal Distribution Function; M(a,b ; ) = The
Cumulative Bivariate Normal Distribution Function with upper integral limits
a and b and correlation coefficient .
-
c
S is the critical ex-dividend stock price that solves:
( )
2 1
, ,
c c
Call S X T t S D X = +

- Where ( )
2 1
, ,
c
Call S X T t = the price of European call with stock
price of I and time to maturity
2 1
T t
PAYOFFS
The payoff of this model can be represented as follows (for buying a call)

NB: "Payoff" Chart represents prices seven days before expiry, not payoffs formulas
INSTRUMENT PRICE
The price of this model according to the price of the underlying asset and
the time to maturity can be represented as follows (for buying a call)

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

12

6.A. AMERICAN APPROXIMATIONS: THE BARONE-ADESI AND WHALEY APPROXIMATION
DESCRIPTION
This quadratic approximation method by Barone-Adesi and Whaley (1987)
allows to price American call and put options on an underlying asset with
cost-of-carry rate b. When b > r, the American call value is equal to the
European call value and can then be found by using the generalized Black-
Scholes-Merton (BSM) formula. This model is fast and accurate for most
practical input values.
2
*
2 *
( , , ) when
( , , )
else
Q
GBS
S
Call S X T A S S
Call S X T
S
S X
| |
+ <
|
=
\ .

1
**
1 **
( , , ) when
( , , )
else
Q
GBS
S
Put S X T A S S
Put S X T
S
X S
| |
+ >
|
=
\ .
Where:

GBS
Call and
GBS
Put are respectively the values of Europeans Call
and put options computed by General Black Scholes formula.
( )
( )
**
( ) **
1 1
1
*
( ) *
2 1
2
1 ( )
1 ( )
b r T
b r T
S
A e CND d S
Q
S
A e CND d S
Q
( =

( =

2 2
1 2
( 1) ( 1) 4 ( 1) ( 1) 4
;
2 2
M M
N N N N
K K
Q Q
+ + +
= =
2 2
2 2
; N= ; 1
rT
r b
M K e
o o

= = With:

- S = Stock Price
- b = cost of carry rate
- X = Strike Price
- T = Time to option expiration
- CND(x)= The Cumulative Normal Distribution Function
-
**
S = the critical commodity price for put options
-
*
S = the critical commodity price for call options

*
S
and
**
S

are determined by using the Newton-Raphson algorithm.


13

PAYOFFS


INSTRUMENT PRICE

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

14

6.B. AMERICAN APPROXIMATIONS: THE BJERKSUND AND STENSLAND APPROXIMATION
DESCRIPTION
The Bjerksund and Stensland (1993) approximation can be used to price
American options on stocks, futures, and currencies. The method is analytical
and extremely computer-efficient. Bjerksund and Stensland's approximation
is based on an exercise strategy corresponding to a flat boundary / (trigger
price). It is demonstrated that the Bjerksund and Stensland approximation is
somewhat more accurate for long-term options than the Barone-Adesi and
Whaley approximation.
2 2
Call(X,S,T,r,b, ) = S (S, T, ,I, I) + (S, T, 1, I, I) - (S, T, 1, X, I)
- X (S, T, 0, I, I) + X (S,T, 0, X, I)
1 1
Where ( ) and
2 2
b b
I X I
|
|
o o o| | | |
| |
o |
o o
| | |
= = +
|
\ . \
2
2
2
r
o
|
+
|
.
The function (S, T, ,H, I) | is given by
2ln( / )
(S, T, ,H, I)=e ( )
k
I I S
S CND d N d
S T

|
o
(
| | | |

(
| |
\ . \ . (

2
2
1
( 1)
2
1
ln( / ) ( )
2
r b T
S H b T
d
T
o
o
o
(
= + +
(

(
+ +
(

=

2
2
(2 1)
b
k
o
= +
And the trigger price I is defined as
( ) 0
0 0
0
0
( )(1 ) and ( ) ( 2 )
and max ,
1
h T
B
I B B B e h T bT T
B B
r
B X B X X
r b
o
|
|
| |
= + = +
|
\ .
( | |
= =
| (
\ .

If S I > , it is optimal to exercise the option immediately, and the value
must be equal to the intrinsic value of S-X. on the other hand, if b r > , it will
never be optimal to exercice the American call option before expiration, and
the value can be found using the generalized black-scholes formula. The
value of the American put is given by the Bjerksund and Stensland put-call
transformation:
Put (S, X, T, r, b, ) ( , , T, r-b, b, ) Call X S o o =

Where Call(.) is the value of an American call with risk-free rate r-b and drift
b. With the use of this transformation, it is not necessary to develop a
separate formula for an American put option.


15

PAYOFFS

NB : "Payoffs" Charts represent prices seven days before expiry, not payoffs formulas

INSTRUMENT PRICE

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

16

7. THE MILTERSEN AND SCHWARTZ COMMODITY OPTION MODEL
DESCRIPTION
Miltersen and Schwartz (1998) developed an advanced model for pricing
options on commodity futures. The model is a three-factor model with
stochastic futures price, a term structure of convenience yields and interest
rates. The model assumes commodity prices are log-normally distributed
and that continuously compounded forward interest rates and future
convenience yields are normally distributed (aka Gaussian).
Investigations using this option pricing model show that the time lag
between the expiration on the option and the underlying futures will have a
significant effect on the option value. Even with three stochastic variables,
Miltersen and Schwartz manage to derive a closed-form solution similar to a
BSM-type formula. The model can be used to price European options on
commodity futures.
1 2
( ) ( )
xz
t T
Call P F e CND d XCND d
o
( =

Where t is the time to maturity of the option,
T
F is a futures price with time
to expiration T, and
t
P is a zero coupon bond that expires on the options
maturity.
2
1 2 1
ln( / ) / 2
,
T xz z
z
z
F X
d d d
o o
o
o
+
= =
And the variances and covariance can be calculated as
2
2
2
0 0
0
0
( ) ( , ) ( , ) ( )
( , ) . ( ) ( , ) ( , )
( ). ( ) .
T
t t
t T t
z s f e F
u
t t T
xz f s f e
u u
t
P F
u u s u s ds du u du
u s ds u u s u s ds du
u u du
o o o o o
o o o o o
o o
( = + =

(
( = +
` (

)
=
} } }
} } }
}

Where
( ) ( , )
( ) ( ) ( , ) ( , )
t
t
T
P f
t
T
F s f e
t
t t s ds
t t t s t s ds
o o
o o o o
=
( = +

}
}

This is an extremely flexible model where the variances and covariances
admits several specifications.


17

PAYOFFS


INSTRUMENT PRICE

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

18

8. EXECUTIVE STOCK OPTI ONS
DESCRIPTION
Executive stock options are priced by the Jennergren and Naslund (1993)
formula which takes into account that an employee or executive often loses
his options if he has to leave the company before the option's expiration.
( )
1 2
( ) ( )
T b r T rT
Call e Se CND d Xe CND d

( =

( )
2 1
( ) ( )
T rT b r T
Put e Xe CND d Se CND d

( =

Where:
2
1 2 1
ln( / ) ( / 2)
d
S X b T
d d T
T
o
o
o
+ +
= =
is the jump rate per year. The value of the executive option equals the
ordinary Black-Scholes option price multiplied by the probability
T
e

that
the executives will stay with the firm until the option expires.

PAYOFFS

INSTRUMENT PRICE

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

19

9. FORWARD START OPTIONS
DESCRIPTION
Forward start options with time to maturity T starts at-the-money or
proportionally in- or out-of-the-money after a known time t in the future.
The strike is set equal to a positive constant
o
times the asset price S after
the known time t. If
o
is less than unity, the call (put) will start 1 -
o

percent in-the-money (out-of-the money); if
o
is unity, the option will start
at-the-money; and if
o
is larger than unity, the call (put) will start
o
- 1
percentage out-of-the money (in-the-money). A forward start option can be
priced using the Rubinstein (1990) formula.

( ) ( )( ) ( )
1 2
( ) ( )
b r t b r T t r T t
Call Se e CND d e CND d o

( =

( ) ( ) ( )( )
2 1
( ) ( )
b r t r T t b r T t
Put Se e CND d e CND d o

( =

Where:
2
1 2 1
ln(1/ ) ( / 2)( )
; d
b T t
d d T t
T t
o o
o
o
+ +
= =

With: t= t1= Starting time of the option

PAYOFFS
INSTRUMENT PRICE

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

20

10. TIME SWITCH OPTIONS
DESCRIPTION
A discrete time-switch call option, introduced by Pechtl (1995), pays an
amount
A t A
at maturity T for each time interval
t A
the corresponding
asset price
i t
S
A
has exceeded the strike price X. The discrete time-switch
put option gives a similar payoff
A t A
at maturity T for each time interval
t A

the asset price
i t
S
A
has been below the strike price X.
2
1
ln( / ) ( / 2)
n
rT
i
S X b i t
Call Ae N t
i t
o
o
=
| | + A
= A
|
A
\ .

2
1
ln( / ) ( / 2)
n
rT
i
S X b i t
Put Ae N t
i t
o
o
=
| | A
= A
|
A
\ .

With:
- A: accumulated amount
-
/ n T t = A

If some of the option's total lifetime has already passed, it is necessary to
add a fixed amount At Ae -rT m to the option pricing formula, where m is the
number of time units where the option already has fulfilled its condition.

PAYOFFS

INSTRUMENT PRICE

21

11.A. SIMPLE CHOOSER OPTIONS
DESCRIPTION
A simple chooser option gives the right to choose whether the option is to be
a standard call or put after a time t1, with strike X and time to maturity T2.
The payoff from a simple chooser option at time t1 (t1 < T2) is
| |
1 2 2 2
( , , , ) max ( , , ), ( , ,
GBS GBS
w S X t T Call S X T Put S X T =

Where
2
( , , )
GBS
Call S X T
and
2
( , , )
GBS
Put S X T
are the general Black-
Scholes call and put formulas.

A simple chooser option can be priced using the formula originally published
by Rubinstein (1991c):
2 2
2 2
( )
2
( )
1
( ) ( )
( ) ( )
b r T rT
b r T rT
Payoff w Se CND d Xe CND d T
Se CND y Xe CND y t
o
o

= =
+ +

Where
2 2
2 2 1
2 1
ln( / ) ( / 2) ln( / ) / 2
; y =
S X b T S X bT t
d
T t
o o
o o
+ + + +
=

PAYOFFS
The payoff of this model can be represented as follows

NB : "Payoff" Chart represents prices seven days before expiry, not payoffs formulas
INSTRUMENT PRICE
the time to maturity can be represented as follows

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

22

11.B. COMPLEX CHOOSER OPTIONS
DESCRIPTION
A Complex chooser option gives the right to choose whether the option is to
be a standard call option after a time t, with time to expiration
C
T
and strike
C
X
, or a put option with time to maturity
P
T
and strike
P
X
. The difference
with regard to simple chooser options is that the calls and the puts will have
different strikes (
C
X
and
P
X
) and maturities (
C
T
and
P
T
).
The payoff from a complex chooser option at time t (t <
C
T
, T) is
| | ( , , , , , ) max ( , , ), ( , ,
C P C P GBS C C GBS P P
w S X X t T T Call S X T Put S X T =

Where
( , , )
GBS C C
Call S X T
and
( , , )
GBS P P
Put S X T
are the general Black-
Scholes call and put formulas.
A Complex chooser option can be priced using the formula originally
published by Rubinstein (1991c):
( )
1 1 1 2 1 1
( )
1 2 2 2 2 2
( , , ) ( , , )
( , , )+ ( , , )
C C
P P
b r T rT
C C
b r T rT
P P
w Se M d y X e M d y T
Se M d y X e M d y T
o
o

=
+

Where
2
1 2 1
ln( / ) ( / 2)
d
S I b t
d d t
t
o
o
o
+ +
= =

2 2
1 2
1 2
ln( / ) ( / 2) ln( / ) ( / 2)
y
/ /
C C P P
C P
C P
S X b T S X b T
y
T T
t T t T
o o
o o

+ + + +
= =
= =

- S = The spot of the underlying asset
- b = The cost of carry
- r = The risk free rate
- X = The strike price
-
1
t
= Time to when the holder must choose call or put
-
2
T
= Time to maturity
-
C
T
= The time to maturity of the call.
-
P
T
= The time to maturity of the put.
- M(a,d; ) = The cumative bivariate normal distribution function.
- N(x) = The normal distribution function
And I is the solution to
( ) ( )( ) ( ) ( )( )
1 1 2 2
2 2
1 2
( ) ( ) ( ) ( ) 0
ln( / ) ( / 2)( ) ln( / ) ( / 2)( )
With and z
p C C P
r T t b r T t r T t b r T t
C C P p
C C P P
C P
Ie N z X e N z T t Ie N z X e N z T t
I X b T t I X b T t
z
T t T t
o o
o o
o o

+ + =
+ + + +
= =


23

PAYOFFS
The payoff of this model can be represented as follows (for buying the
option):

NB : "Payoff" Chart represent prices seven days before expiry, not payoffs formulas
INSTRUMENT PRICE
the time to maturity can be represented as follows (for buying the
option)

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

24

12. OPTIONS ON OPTIONS
DESCRIPTION
This pricer allows to price options on options, namely, call on call, put on call,
call on put and put on put. The pricing of such options is based on works of
Geske(1979), Hodges and selby (1987) and Rubinstein (1999).

CALL ON CALL

| |
2 2 1
1 2 2
( )
1 1 1 2 2 2 2
( , , ) ; 0
( , , ) ( , , ) ( )
GBS
b r T rT rt
call
Payoff Max Call S X T X
Call Se M z y X e M z y X e N y

=
=

2
1
1 2 1 1
1
2
1 2
1 2 1 2
2
1 2
ln( / ) ( / 2)
y
ln( / ) ( / 2)
z
/
S I b t
y y t
t
S X b T
z z T
T
t T
o
o
o
o
o
o
+ +
= =
+ +
= =
=

-
1
X : strike price of the underlying option
-
2
X : strike price of the option on the option
-
2
T : time to maturity of the underlying option
-
1
t : time to maturity of the option on option
-
1 2
( , , )
GBS
Call S X T
: the black-scholes generalized formula with
strike
1
X
and time to maturity
2
T

- M(a,d; ) = The cumative bivariate normal distribution function

PUT ON CALL
| |
2 2 1
2 1 2
( )
1 2 2 1 1 2 2
( , , ); 0
( , , ) ( , , ) ( )
GBS
rT b r T rt
Call
Payoff Max X Call S X T
Put X e M z y Se M z y X e N y

=
= +

Where the value I is found by solving the equation
1 2 1 2
( , , )
GBS
Call I X T t X =
CALL ON PUT
| |
2 2 1
1 2 2
( )
1 2 2 1 1 2 2
( , , ) ; 0
( , , ) ( , , ) ( )
GBS
rT b r T rt
put
Payoff Max Put S X T X
Call X e M z y Se M z y X e N y

=
=

PUT ON PUT
| |
2 2 1
2 1 2
( )
1 1 1 2 2 2 2
( , , ); 0
( , , ) ( , , ) ( )
GBS
b r T rT rt
put
Payoff Max X Put S X T
Put Se M z y X e M z y X e N y

=
= +

Where the value I is found by solving the equation
1 2 1 2
( , , )
GBS
Put I X T t X =


25

PAYOFFS
The payoffs of this model can be represented as follows:
(for 4 positions: buying a call on call, buying a call on put, buying a put on
call, buying a put on put )

Call on Call Call on Put

Put on Call Put on Put

INSTRUMENT PRICE
The prices of this model according to the price of the underlying asset and
the time to maturity could be represented as follows (for 4 positions: buying
a call on call, buying a call on put, buying a put on call, buying a put on put )
Call on Call Call on Put

Put on Call Put on Put

0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

26

13. WRITER EXTENDIBLE OPTIONS
DESCRIPTION
In general, extendible options are options where maturity can be extended.
Such options can be found embedded in several financial contracts. For
example, corporate warrants have frequently given the corporate issuer the
right to extend the life of the warrants. Another example is options on real
estate where the holder can extend the expiration by paying an additional
fee. Pricing of such extendible options was introduced by Longstaff (1990). In
particular, Writer extendible options can be exercised at their initial maturity
date
1
t but are extended to
2
T if the option is out-of-the-money at
1
t .
EXTENDIBLE CALL
Payoff

1 1
1 2 1 2
2 2 1
( ) if
( , , , , )
Call (S,X ,T -t ) else
GBS
S X S X
Call S X X t T
>
=

Value

2
2
( )
1 1 1 2
2 1 2 2 1
( , , ) ( , ; )
( , ; )
b r T
GBS
rT
Call Call S X t Se M z z
X e M z T z t

o o
= +
+

EXTENDIBLE PUT
Payoff
1 1
1 2 1 2
2 2 1
( ) if
( , , , , )
(S,X ,T -t ) else
GBS
X S S X
Put S X X t T
Put
<
=

Value

2
2
1 1 2 1 2 2 1
( )
1 2
( , , ) ( , ; )
( , ; )
rT
GBS
b r T
Put Put S X t X e M z T z t
Se M z z
o o
= + +

Where
2 2
2 2 1 1
1 2 1 2
2 1
ln( / ) ( / 2) ln( / ) ( / 2)
; z ; /
S X b T S X b t
z t T
T t
o o

o o
+ + + +
= = =
All formulas with
-
1
X : strike price of the original maturity
-
2
X : strike price of the extendible maturity
-
2
T : time to maturity of the extendible maturity
-
1
t : time to maturity of the extendible option
-
1 2
( , , )
GBS
Call S X T
: the black-scholes generalized formula with
strike
1
X
and time to maturity
2
T



27

PAYOFFS


INSTRUMENT PRICE

0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

28

14. TWO ASSETS CORRELATION OPTIONS
DESCRIPTION
This call option pays off max(S2 - X2; 0) if S1 > X1 and 0 otherwise. The put
pays off max(X2 - S2) if S1 < X1 and 0 otherwise. These options are priced
using the formulas of Zhang (1995).
2
( )
2 2 2 1 2 2 2 1
( , ; ) ( , ; )
b r T rT
Call S e M y T y T X e M y y o o

= + +
2
( )
2 2 1 2 2 2 1 2
( , ; ) ( , ; )
b r T rT
Put X e M y y S e M y T y T o o

=
Where
2 2
1 1 1 1 2 2 2 2
1 2
1 2
ln( / ) ( / 2) ln( / ) ( / 2)
;
S X b T S X b T
y y
T T
o o
o o
+ +
= =
With
-
1
S = The spot of the asset 1;
2
S = The spot of the asset 2
-
1
X = Strike of asset 1;
2
X = Strike of asset 2
-
1
b = The cost of carry of asset 1 ;
2
b = The cost of carry of asset 2;
-
1
o = The volatility of the asset 1;
2
- r = The risk free rate; = Correlation between assets 1 and 2;
- T = Time to expiry of the option
PAYOFFS

INSTRUMENT PRICE


29

15. OPTION TO EXCHANGE ONE ASSET FOR ANOTHER
DESCRIPTION
An exchange-one-asset-for-another option gives the holder the right, as its
name indicates, to exchange one asset
2
S for another
1
S at expiration. The
payoff from an exchange-one-asset-for-another option is
1 1 2 2
( ;0) Max QS Q S .
EUROPEAN CALL
1 2
( ) ( )
1 1 1 2 2 2
( ) ( )
b r T b r T
Call QS e CND d Q S e CND d

=
where
2
1 1 2 2 1 2
1 2 1
ln( / ) ( / 2)
;
QS Q S b b T
d d d T
T
o
o
o
+ +
= =
2 2
1 2 1 2
2 o o o o o = +
and where
-
1
S = The spot of the underlying asset 1
-
2
-
1
2
b = The cost of carry of asset 2
-
1
2
o = The volatility of the asset 2

- = Correlation between assets 1 and 2
-
1
Q
= Quantity of asset 1
-
2
Q
= Quantity of asset 2
- CND = The cumulative normal distribution function
AMERICAN CALL
Bjerksund and Stensland (1993) showed that an American Exchange one asset
for another option (S2 for S1) can be priced using a formula for pricing a plain
vanilla American option, with the underlying asset S1 with a risk-adjusted drift equal
to b1-b2, the strike price equal to S2 , time to maturity T, risk free rate equal to r-b2,
and volatilityequal to (defined in the same way as it is for the European option).


30

PAYOFFS
buying a European call in the left side and buying an American call in the
right side)


INSTRUMENT PRICE
the time to maturity can be represented as follows for 2 positions: buying a
European call in the left side and buying an American call in the right side)

0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,22
0,42
0,62
0,82
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

31

16. EXCHANGE OPTIONS ON EXCHANGE OPTIONS
DESCRIPTION
An Exchange options on exchange options can be found embedded in
sequential exchange opportunities. An example described by Carr (1988) is a
bond holder converting into a stock and later exchanging the shares received
for stocks of an acquiring firm. Those options can be priced analytically using
a model introduced by Carr (1988).
[1] Option to exchange Q*S2 for the option to exchange S2 for S1
The value of the option to exchange the option to exchange a fixed
quantity Q of asset
2
S for the option to exchange asset
2
S for
1
S is :
1 2 2 2
2 1
( ) ( )
1 1 1 1 2 2 2 2 1 2
( )
2 2
( , ; / ) ( , ; /
( )
b r T b r T
b r t
Call S e M d y t T S e M d y t T
QS e CND d

where
2
1 2 1 2 1
1 2 1 1
1
2
2 1 2 1 1
3 4 3 1
1
ln( / ) ( / 2)
;
ln( / ) ( / 2)
;
S IS b b t
d d d t
t
IS S b b t
d d d t
t
o
o
o
o
o
o
+ +
= =
+ +
= =

2
1 2 1 2 2
1 2 1 2
2
2
2 1 2 1 2
3 4 3 2
2
ln( / ) ( / 2)
; y
ln( / ) ( / 2)
;
S S b b T
y y T
T
S S b b T
y y y T
T
o
o
o
o
o
o
+ +
= =
+ +
= =

2 2
1 2 1 2
2 o o o o o = +

[2] Option to exchange the option to exchange S2 for S1 in return for Q*S2
The value of the option to exchange asset
2
S for
1
S in return for a
fixed quantity Q of asset
2
S is :
2 2 1 2
2 1
( ) ( )
2 3 2 1 2 1 4 1 1 2
( )
2 3
( , ; / ) ( , ; / )
( )
b r T b r T
b r t
QS e CND d

I is the unique critical price ratio
1 2 1
2 2 1
( )( )
1
1 ( )( )
2
b r T t
b r T t
S e
I
S e

= solving
1 1 2
2
1 2 1
1 2 1 2 1
2 1
( ) ( )
ln( ) ( ) / 2
;
I N z N z Q
I T t
z z z T t
T t
o
o
o
=
+
= =


32


[3] Option to exchange Q*S2 for the option to exchange S1 for S2
The value of the option to exchange a fixed quantity Q of asset
2
S for the
option to exchange asset
1
S for
2
S is:
2 2 1 2
2 1
( ) ( )
2 3 3 1 2 1 4 4 1 2
( )
2 3
( , ; / ) ( , ; / )
( )
b r T b r T
b r t
QS e CND d

[4] Option to exchange the option to exchange S1 for S2 in return for Q*S2
The value of the option to exchange the option to exchange asset
1
S for
2
S
in return for a fixed quantity Q of asset
2
S is :
1 2 2 2
2 1
( ) ( )
1 1 4 1 2 2 2 3 1 2
( )
2 2
( , ; / ) ( , ; / )
( )
b r T b r T
b r t
QS e CND d

=
+

where I is now the unique critical price ratio
2 2 1
1 2 1
( )( )
2
2 ( )( )
1
b r T t
b r T t
S e
I
S e

= that solves
1 2 2
2
2 2 1
1 2 1 2 1
2 1
( ) ( )
ln( ) ( ) / 2
;
N z I N z Q
I T t
z z z T t
T t
o
o
o
=
+
= =

where
-
1
-
2
-
1
b = The cost of carry of the asset 1
-
2
b = The cost of carry of the asset 2
-
1
o
= Volatility of asset 1
-
2
o
= Volatility of asset 2
-
1
t
= Time to expiration of the "original" option.
-
2
T
= Time to expiration of the underlying option (T2 > t1)
- = Correlation between assets 1 and 2.
- Q = Quantity of asset delivered if option is exercised
- CND = The cumulative normal distribution function


33

PAYOFFS

[1] Q2S2 for Option (S2 for S1) [2] Q2S2 for Option (S1 for S2)

[3] Option (S2 for S1) for Q2S2 [4] Option (S1 for S2) for Q2S2

INSTRUMENT PRICE
the time to maturity can be represented as follows:

[1] Q2S2 for Option (S2 for S1) [2] Q2S2 for Option (S1 for S2)
[3] Option (S2 for S1) for Q2S2 [4] Option (S1 for S2) for Q2S2


34

17. OPTIONS ON THE MAXIMUM OR THE MINIMUM OF TWO RISKY ASSETS
DESCRIPTION
These options on the minimum or maximum of two risky assets are priced by
using the formula of Stulz (1982) witch have later been extended and
discussed by Johnson (1987), Rubinstein (1991) and others.
[1] CALL ON THE MAXIMUM OF TWO ASSETS
| |
1 2
: min( , ) , 0 Payoff Max S S X

( )
1
2
( )
min 1 2 1 1 1
( )
2 2 2 1 1 2 2
( , , , ) , ;
( , ; ) ( , ; )
b r T
b r T rT
Call S S X T S e M y d
S e M y d T Xe M y T y T
o o o

=
+
2 2
1 2 1 2 1 1 1
1
1
2
2 2 2
2
2
ln( / ) ( / 2) ln( / ) ( / 2)
Where ;
ln( / ) ( / 2)
S S b b T S X b T
d y
T T
S X b T
y
T
o o
o o
o
o
+ + + +
= =
+ +
=

2 2 1 2 2 1
1 2 1 2 1 2
2 ; ;
o o o o
o o o o o
o o

= + = =

[2] CALL ON THE MAXIMUM OF TWO ASSETS
| |
1 2
: max( , ) , 0 Payoff Max S S X
( )
1 2
( ) ( )
min 1 2 1 1 1 2 2 2
1 1 2 2
( , , , ) , ; ( , ; )
1 ( , ; )
b r T b r T
rT
Call S S X T S e M y d S e M y d T
Xe M y T y T
o
o o

= + +
(
+ +

[3] PUT ON THE MINIMUM OF TWO ASSETS
| |
1 2
: min( , ), 0 Payoff Max X S S
min 1 2 min 1 2 min 1 2
( , , , ) ( , , 0, ) ( , , , )
rT
Put S S X T Xe Call S S T Call S S X T
= +
1 1 2
( ) ( ) ( )
min 1 2 1 1 2
Where ( , , 0, ) ( ) ( )
b r T b r T b r
Call S S T S e S e CND d S e CND d T o

= +

[4] PUT ON THE MAXIMUM OF TWO ASSETS
| |
1 2
: max( , ), 0 Payoff Max X S S
max 1 2 max 1 2 max 1 2
( , , , ) ( , , 0, ) ( , , , )
rT
Put S S X T Xe Call S S T Call S S X T
= +
2 1 2
( ) ( ) ( )
max 1 2 2 1 2
Where ( , , 0, ) ( ) ( )
b r T b r T b r
Call S S T S e S e CND d S e CND d T o

=


35

PAYOFFS


[1] Call on Minimum [2] Call on Maximum

[3] Put on Minimum [4] Put on Maximum
NB : "Payoffs" Charts represent prices seven days before expiry, not payoffs formula

INSTRUMENT PRICE

The prices of this model according to the price of the underlying asset and the
time to maturity can be represented as follows:

[1] Call on Minimum [2] Call on Maximum

[3] Put on Minimum [4] Put on Maximum

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot 0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

36

18. SPREAD OPTION APPROXIMATION
DESCRIPTION
A European spread option is constructed by buying and selling equal number
of options of the same class on the same underlying asset but with different
strike prices or expiration dates. They can be valued using the standard Black
Scholes (1973) model by performing the following transformation, as
originally shown by Kirk(1995).
CALL SPREAD
1
1 2 2
2
: ( , 0) max 1, 0 ( )
S
Payoff Max S S X S X
S X
| |
= +
|
+
\ .

| |
2
( )
2 2 1 2
( ) ( ) ( )
b r T rT
Call Q S e Xe SN d N d

~ +

PUT SPREAD
1
1 2 2
2
: ( , 0) max 1 , 0 ( )
S
Payoff Max X S S S X
S X
| |
+ = +
|
+
\ .

| |
2
( )
2 2 2 1
( ) ( ) ( )
b r T rT
Put Q S e Xe N d SN d

~ +

Where
2
1 2 1
ln( ) ( / 2)
;
S T
d d d T
T
o
o
o
+
= =
1
2
( )
1 1
( )
2 2
b r T
b r T rT
QS e
S
Q S e Xe

=
+

And the volatility can be approximated by
2 2
1 2 1 2
( ) 2 F F o o o o o ~ +
Where
2
2
( )
2 2
( )
2 2
b r T
b r T rT
Q S e
F
Q S e Xe

=
+

where
- = The spot of the underlying asset 1
- = The spot of the underlying asset 2
- = Quantity of asset 1
- = Quantity of asset 2
-
1
2
b = The cost of carry of asset 2
-
1
2
o = The volatility of the asset 2
- = Correlation between assets 1 and 2
- CND = Cumulative Normal Distribution
1
S
2
S
1
Q
2
Q

37

PAYOFFS



INSTRUMENT PRICE

The prices of this model according to the price of the underlying asset and the
time to maturity can be represented as follows (for 2 positions: buying a call in the
left side and buying a put in the right side)

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

38

19. FLOATING STRIKE LOOKBACK OPTIONS
DESCRIPTION
A floating strike lookback call gives the holder the right to buy the underlying
asset at the lowest price observed,
min
S , during the options lifetime.
Similarly, a floating-strike put gives the holder the right to sell the underlying
asset at the higher price observed,
max
S , during the options lifetime.
Floating Strike Lookback Call
min
: ( ;0) Payoff Max S S
2
( )
1 min 2
2
2
1 1
min
if b 0 then
( ) ( )
2
( )
2
b r T rT
b
bT rT
Call Se N a S e N a
S b
Se N a T e N a
b S
o
o
o

=
=
(
| |
| |
(
+ +
| |
(
\ .
\ .
(

| |
1 min 2 1 1 1
And if b=0 we have
( ) ( ) ( ) ( ( ) 1)
rT rT rT
Call Se N a S e N a Se T n a a N a o

= + +

Where
2
min
1 2 1
ln( / ) ( / 2)
a
S S b T
a a T
T
o
o
o
+ +
= =

Floating Strike Lookback Put
max
: ( ;0) Payoff Max S S
2
( )
max 2 1
2
2
1 1
max
if b 0 then
( ) ( )
2
( )
2
rT b r T
b
bT rT
Put S e N b Se N b
S b
Se N b T e N b
b S
o
o
o

=
=
(
| |
| |
(
+ +
| |
(
\ .
\ .
(

| |
( )
max 2 1 1 1 1
And if b=0 we have
( ) ( ) ( ) ( ) )
rT b r T rT
Put S e N b Se N b Se T n b N b b o

= + +

Where
2
max
1 2 1
ln( / ) ( / 2)

S S b T
b b b T
T
o
o
o
+ +
= =

PAYOFFS

39



INSTRUMENT PRICE
the time to maturity can be represented as follows (for 2 positions: buying a
call in the left side and buying a put in the right side)


40

20. FIXED STRIKE LOOKBACK OPTIONS
DESCRIPTION
In a fixed-strike lookback call, the strike is fixed in advance. At expiration, the
option pays out the maximum of the difference between the highest
observed price during the option's lifetime,
max
S
and the strike X, and 0.
Similarly, a put at expiration pays out the maximum of the difference
between the fixed-strike X and the minimum observed price
min
S
, and 0.
Fixed-strike lookback options can be priced using the Conze and Viswanathan
(1991) formula.
FIXED-STRIKE LOOKBACK CALL
max
: ( ;0) Payoff Max S X
2
( )
1 2
2
2
1 1
( ) ( )
2
( )
2
b r T rT
b
bT rT
Call Se N d Xe N d
S b
Se N d T e N d
b X
o o
o

=
(
| | | |
(
+ +
| |
(
\ . \ .

Where
2
1 2 1
ln( / ) ( / 2)
;
S X b T
d d d T
T
o
o
o
+ +
= =
2
( )
max max 1 max 2
2
2
1 1
max
When X S : ( ) ( ) ( )
2
( )
2
rT b r T rT
b
bT rT
Call e S X Se N e S e N e
S b
Se N e T e N e
b S
o
o
o

s = +
(
| |
| |
(
+ +
| |
(
\ .
\ .
(

2
max
1 2 1
ln( / ) ( / 2)
Where and e
S S b T
e e T
T
o
o
o
+ +
= =
FIXED STRIKE LOOKBACK PUT
min
: ( ;0) Payoff Max X S
2
( )
2 1
2
2
1 1
( ) ( )
2
( )
2
rT b r T
b
bT rT
Put Xe N d Se N d
S b
Se N d T e N d
b X
o o
o

=
(
| | | |
(
+ +
| |
(
\ . \ .

2
( )
min min 1 min 2
2
2
1 1
min
When X S : ( ) ( ) ( )
2
( )
2
rT b r T rT
b
bT rT
Put e X S Se N f S e N f
S b
Se N f T e N f
b S
o
o
o

> = +
(
| |
| |
(
+ +
| |
(
\ .
\ .
(

2
min
1 2 1
ln( / ) ( / 2)
Where and
S S b T
f f f T
T
o
o
o
+ +
= =


41

PAYOFFS



INSTRUMENT PRICE



42

21. PARTIAL-TIME FLOATING-STRIKE LOOKBACK OPTIONS
DESCRIPTION
In the partial-time floating-strike lookback options, the lookback period is at
the beginning of the option's lifetime. Time to expiration is T2, and time to
the end of the lookback period is t1 (t1 < T2). Except for the partial lookback
period, the partial-time floating-strike lookback option is similar to a
standard floating-strike lookback option. However, a partial lookback option
must naturally be cheaper than a similar standard floating-strike lookback
option. Heynen and Kat (1994) have developed formulas for pricing these
options.
PARTIAL TIME FLOATING-STRIKE LOOKBACK CALL
( )
( )
2 2
2
2
2
2
2
( )
1 1 min 2 1
2
1 2
2
1 1 1 1 2
min
2
1 1 1 2 1 2
( )
1 1 1 2 1 2
( ) ( )
2 2
; /
2
, ; 1 /
, ; 1 /
b r T rT
b
rT
b
bT
b r T
Call Se N d g S e N d g
b t b T S
M f d g t T
S
Se
b
e M d g e g t T
Se M d g e g t T
o
o
o
o o
=
(
| |
| |
(
+ + |
|
| (
\ . + \ .
(
(
+ (

+ +

2
2 1 2
min 2 2 1 1 2
2
( ) ( )
2 2 1
( , ; / )
1 ( ) ( )
2
rT
b T t b r T
S e M f d g t T
e Se N e g N f
b

+
| |
+
|
\ .

The factor enables the creation of so called fractional lookback options
where the strike is fixed at some percentage above or below the actual
extreme, 1 > for calls and 0 1 < s for puts.

Where

2
0 2
1 2 1 2
2
ln( / ) ( / 2)

S M b T
d d d T
T
o
o
o
+ +
= =
2
2 1
1 2 1 2 1
2 1
( / 2)( )
e
b T t
e e T t
T t
o
o
o
+
= =

2
0 1
1 2 1 1
1
ln( / ) ( / 2)

S M b t
f f f t
t
o
o
o
+ +
= =
1 2
2 2 1
ln( ) ln( )
g g
T T t

o o
= =

Where

min
0
max
if call
if put
S
M
S


43

PARTIAL TIME FLOATING-STRIKE LOOKBACK PUT
( )
( )
2 2
2
2
2
2
2
2
( )
max 2 1 1 1
2
1 2
2
1 1 1 1 2
max
2
1 1 1 2 1 2
( )
1 1 1 2 1 2
max 2
( ) ( )
2 2
; /
2
, ; 1 /
, ; 1 /
( ,
rT b r T
b
rT
b
bT
b r T
rT
Put S e N d g Se N d g
b t b T S
M f d g t T
S
Se
b
e M d g e g t T
Se M d g e g t T
S e M f
o
o
o
o o
= + +
(
| |
| |
(
+ |
|
| (
\ . + \ .
(
(
+ + (

+

2 1 2
2 1 1 2
2
( ) ( )
2 2 1
; / )
1 ( ) ( )
2
b T t b r T
d g t T
e Se N e g N f
b
o

+
| |
+ + +
|
\ .

PAYOFFS

INSTRUMENT PRICE


44

22. PARTIAL-TIME FIXED-STRIKE LOOKBACK OPTIONS
DESCRIPTION
For Partial-Time Fixed-Strike Lookback option, the lookback period starts at a
predetermined date
1
t after the option contract is initiated. The partial time
fixed-strike lookback call payoff is given by the maximum of the highest
observed price of the underlying asset in the lookback period, in excess of
the strike price X, and 0. The put pays off the maximum of the fixed-strike
price X minus the minimum observed asset price in the lookback period
2 1
( ) T t
min
S , and 0. This option is naturally cheaper than a similar standard
fixed-strike lookback option. Partial-time fixed strike lookback options can be
priced analytically using a model introduced by Heynen and Kat (1994).
PARTIAL TIME FIXED-STRIKE LOOKBACK CALL
( )
( )
2 2
2
2
2
2 2
2 1
( )
1 2
2
2 1
2
1 1 1 2
1 1 1 2
( )
1 1 1 2 2 2 1 2
2
( ) ( )
( ) ( )
2 2
; /
2
, ; 1 /
, ; 1 / ( , ; / )
1
2
b r T rT
b
rT
bT
b r T rT
b T t b r T
Call Se N d Xe N d
b T b t S
M d f t T
X
Se
b
e M e d t T
Se M e d t T Xe M f d t T
e Se
b
o
o
o o
o

=
(
| |
| |
(
+ |
|
|
(
\ . +
\ .
(
(
+

| |
+
|
\ .
2
1 2
( ) ( ) N f N e

PARTIAL TIME FIXED-STRIKE LOOKBACK PUT

( )
( )
2 2
2
2
2
2
2
2 1
( )
2 1
2
2 1
2
1 1 1 2
1 1 1 2
( )
1 1 1 2
2 2 1 2
2
( ) (
( ) ( )
2 2
, ; /
2
, ; 1 /
, ; 1 /
( , ; / )
1
2
rT b r T
b
rT
bT
b r T
rT
b T t b
Put Xe N d Se N d
b T b t S
M d f t T
X
Se
b
e M e d t T
Se M e d t T
Xe M f d t T
e Se
b
o
o
o o
o

=
(
| |
| |
(
+ |
|
|
(
\ . +
\ .
(
(

+
+
| |

|
\ .
2
)
2 1
( ) ( )
r T
N e N f

Where
1 1 1
, and d e f are defined under the floating-strike Lookback options.


45

PAYOFFS



INSTRUMENT PRICE



46

23. EXTREME-SPREAD OPTIONS
DESCRIPTION
These options are closer to lookback options than spread options, due to the
way the time to maturity is divided. It is divided into two periods: one period
starting today and ending at time
1
t , and another period starting at
1
t and
ending at the maturity of the option
2
T . Extreme spread options can be priced
analytically using a model introduced by Bermin (1996).
EXTREME-SPREAD OPTIONS

1 2 1
1 1 2
( , ) (0, )
max max
(0, ) ( , )
min min
( ) : ( ; 0)
( ) : ( ; 0)
t T t
t t T
Payoff Call Max S S
Payoff Put Max S S

2 2 1 2
( )( )
( )
( ) ( ) ( 1) ( )
( ) ( 1) ( )
DT D r T t DT
extreme
Se KN A e Se
Spread KN B N C k e N D
N E k e N F
o
o
q|
q q| q| q|
q| q|

(
(
= +
(
(
+

2 2 2 1 1 2
2 1 2
1 2 1 1 1 1
2 1 1
Where ; ;
; ;
m T m t m T
A B C
T t T
m T m t m t
D E F
T t t

o o o

o o o
+ +
= = =
+
= = =

2
2
2
2 2
1 2
2
And where ; 1 ; =
2( )
ln( / ) ; 0.5 ; 0.5
rT
e M k
r D
M S r D r D
o e
o
o
e o o
(
= = +
(

= = = +

.
1 if Call 1 if extreme spread 1
; and = ;
-1 if Put 1 if reverse extreme spread 1
MaximumValue if
M
MinimumValue if
|q
q | |
|q
=
= =

=

REVERSE EXTREME-SPREAD OPTIONS

1 2 1
1 1 2
( , ) (0, )
min min
(0, ) ( , )
max max
( ) : ( ; 0)
( ) : ( ; 0)
t T t
t t T
Payoff Call Max S S
Payoff Put Max S S

2
2
2 1 2
( )( )
( ) ( )
( 1) ( ) ( )
( 1) ( )
DT
DT
Reverseextreme
D r T t DT
Se KN A N B
Spread k e N C Se KN G
e Se k N H
o
q| q|
q q| q
q

( +
(
=
(
(

2 2 1 1 2 1
2 1 2 1
( ) ( )
Where ;
T t T t
G H
T t T t

o o

= =


47

PAYOFFS
buying a call in the left sides and buying a put in the right sides)

Extreme Spread options

Reverse Extreme Spread options


INSTRUMENT PRICE
call in the left sides and buying a put in the right sides)
Extreme Spread options

Reverse Extreme Spread options


48

24. STANDARD BARRIER OPTIONS
DESCRIPTION
There are four types of single barrier options. The type flag "cdi" denotes a
down-and-in call, "cui" denotes an up-and-in call, "cdo" denotes a down-and-
out call, and "cuo" denotes an up-and-out call. Similarly, the type flags for
the corresponding puts are pdi, pui, pdo, and puo. A down-and-in option
comes into existence if the asset price, S, falls to the barrier level, H. An up-
and-in option comes into existence if the asset price rises to the barrier level.
A down-and-out option becomes worthless if the asset price falls to the
barrier level. An up-and-out option becomes worthless if the asset price rises
to the barrier level. In general a prespecified cash rebate K is included. It is
paid out at option expiration if the option has not been knocked in during its
lifetime for in barriers or if the option is knocked out before expiration for
out barriers.
European single barrier options can be priced analytically using a model
introduced by Reiner and Rubinstein (1991).

The different formulas use a common set of factors:
( )
1 1
( )
2 2
( ) 2( 1) 2
1 1
( ) 2( 1) 2
2 2
2
2
( ) ( )
( ) ( )
( / ) ( ) ( / ) ( )
( / ) ( ) ( / ) ( )
( ) ( / ) (
b r T rT
b r T rT
b r T rT
b r T rT
rT
A Se N x Xe N x T
B Se N x Xe N x T
C Se H S N y Xe H S N y T
D Se H S N y Xe H S N y T
E Ke N x T H S N

| | | | |o
| | | | |o
| q | q qo
| q | q qo
q qo q

+
+
=
=
=
=
=
2
)
( / ) ( ) ( / ) ( 2 )
y T
F K H S N z H S N z T

qo
q q qo
+
(

(
= +

Where

1 2
2
1 2
2
2
2 2
ln( / ) ln( / )
(1 ) ; (1 )
ln( / ) ln( / )
(1 ) ; (1 )
ln( / ) / 2 2
; ;
S X S H
x T x T
T T
H SX H S
y T y T
T T
H S b r
z T
T
o o
o o
o o
o o
o
o
o o o
= + + = + +
= + + = + +
= + = = +


49

IN BARRIERS

Down-and-in Call S>H

: ( ; 0) if S H before T else K at expiration
C ( ) =1, 1
C ( ) =1, 1
di
di
Payoff Max S X
X H C E
X H A B D E
q |
q |
s
> = + =
< = + + =

Up-and-in Call S<H

C ( ) =-1, =1
C ( ) =-1, =1
ui
ui
Payoff Max S X
X H A E
X H B C D E
q |
q |
>
> = +
< = + +

Down-and-in put S>H

P ( ) =1, = -1
P ( ) =1, = -1
di
di
Payoff Max X S
X H B C D E
X H A E
q |
q |
s
> = + +
< = +

Up-and-in Put S<H

P ( ) =-1, = -1
P ( ) =-1, = -1
ui
ui
Payoff Max X S
X H A B D E
X H C E
q |
q |
>
> = + +
< = +

OUT BARRIERS

Down-and-out Call S>H

: ( ; 0) if S> H before T else K at hit
C ( ) =1, =1
C ( ) =1, =1
do
do
Payoff Max S X
X H A C F
X H B D F
q |
q |
> = +
< = +

Up-and-out Call S<H

: ( ; 0) if S< H before T else K at hit
C ( ) =-1, =1
C ( ) =-1, =1
uo
uo
Payoff Max S X
X H F
X H A B C D F
q |
q |
> =
< = + +

Down-and-out put S>H

: ( ; 0) if S> H before T else K at hit
( ) =1, =-1
( ) =1, =-1
do
do
Payoff Max X S
P X H A B C D F
P X H F
q |
q |
> = + +
< =

Up-and-out Put S<H

: ( ; 0) if S< H before T else K at hit
( ) =-1, =-1
( ) =-1, =-1
uo
uo
Payoff Max X S
P X H B D F
P X H A C F
q |
q |
> = +
< = +


50

PAYOFFS

The payoffs of this model can be represented as follows (Buying positions,
Rebate = 3):

Call Up and In Call Up and Out

Call Down and In Call Down and Out


Put Up and In Put Up and Out

Put Down and In Put Down and Out


51

INSTRUMENT PRICE

the time to maturity can be represented as follows (Buying positions, Rebate
= 3):






52

25. DOUBLE BARRIER OPTIONS
DESCRIPTION
A double-barrier option is knocked either in or out if the underlying price
touches the lower boundary L or the upper boundary U prior to expiration.
The formulas below pertain only to double knock-out options. The price of a
double knock-in call is equal to the portfolio of a long standard call and a
short double knock-out call, with identical strikes and time to expiration.
Similarly, a double knock-in put is equal to a long standard put and a short
double knock-out put. Doublebarrier options can be priced using the Ikeda
and Kuintomo (1992.)
CALL UP-AND-OUT-DOWN-AND-OUT

| | | |
1 3
2
1
2
1
( )
1 2 3 4
2
1 2
: ( , , , ) ( ; 0) if L<S<U before T else 0.
( ) ( ) ( ) ( )
( ) ( )
n n
b r T
n n
n
n
n
rT
Payoff Call S U L T Max S k
U L L
Call Se N d N d N d N d
L S U S
U L
N d T N d T
L S
Xe
L

o o
+
=

| | | | | |
=
` | | |
\ .
\ . \ .
)
| |
| |
(

| |

\ .
\ .
3
2
1
3 4
( ) ( )
n
n
n
N d T N d T
U S
o o
+
=

`
| |
(

|

\ . )

Where
2 2 2 2 2 2
1 2
2 2 2 2 2 2 2 2
3 4
ln( / ( )) ( / 2) ln( / ( )) ( / 2)
; d
ln( / ( )) ( / 2) ln( / ( )) ( / 2)
; d
n n n n
n n n n
SU XL b T SU FL b T
d
T T
L XSU b T L FSU b T
d
T T
o o
o o
o o
o o
+ +
+ + + +
= =
+ + + +
= =
( ) ( )
( )
1
2 1 1
1 2 2 2
2 1
3 2
2 2 2
1 ; 2
2 2
1 ;
T
b n
n
b n
F Ue
o
o o o o o

o o
o o o
o
(

= + =
+ (

= + =

Where
1
o
and
2
o
determine the curvature of L and U.
PUT UP-AND-OUT-DOWN-AND-OUT

1
2
3
1
2
2
1 2
2
1
3 4
( )
: ( , , , ) ( ; 0) if L<S<U before T else 0.
( ) ( )
( ) ( )
n
n
rT
n
n
n
n
n
b r T
Payoff Put S U L T Max X S
U L
N y T N y T
L S
Put Xe
L
N y T N y T
U S
U L
L S
Se

o o
o o
+
=
=

| |
| |
(

| |

\ . \ .
=
`
| |
(

|

\ . )
| |
| |
| |
\ .
\ .
| |
| |
3
1 2
1
3 4
( ) ( )
( ) ( )
n
n
n
N y N y
L
N y N y
U S
+
=

`
| |

|
\ . )


53


Where
2
2 2 2 2 2 2
2
1 2
2 2 2 2 2 2 2 2
3 4
ln( / ( )) ( / 2) ln( / ( )) ( / 2)
; ;
ln( / ( )) ( / 2) ln( / ( )) ( / 2)
;
n n n n
T
n n n n
SU EL b T SU XL b T
y y E Le
T T
L ESU b T L XSU b T
y y
T T
o
o o
o o
o o
o o
+ +
+ + + +
= = =
+ + + +
= =

CALL UP-AND-IN-DOWN-AND-IN

Up-and-Out-Down-and-Out
Call
GBS
Call Call =
PUT UP-AND-IN-DOWN-AND-IN

Up-and-Out-Down-and-Out

GBS
Put Put Put =


54

PAYOFFS

The payoffs of this model can be represented as follows (Buying positions):

Call Out Call In

Put Out Put in


INSTRUMENT PRICE

the time to maturity can be represented as follows (Buying positions):
Call out Call In

Put Out Put in

0
10
20
30
40
50
60
70
80
90
100
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
80
90
100
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
80
90
100
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
80
90
100
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
80
90
100
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
80
90
100
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
80
90
100
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
80
90
100
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

55

26. PARTIAL-TIME SINGLE ASSET BARRIER OPTIONS
DESCRIPTION
For single asset partial-time barrier options, the monitoring period for a
barrier crossing is confined to only a fraction of the option's lifetime. There
are two types of partial-time barrier options: partial-time-start (type A) and
partial-time-end (type B). Partial-time-start barrier options (type A) have the
monitoring period start at time zero and end at an arbitrary date before
expiration. Partial-time-end barrier options (Type B) have the monitoring
period start at an arbitrary date before expiration and end at expiration.
Partial-time-end barrier options (type B) are then broken down again into
two categories: B1 and B2. Type B1 is defined such that only a barrier hit or
crossed causes the option to be knocked out. There is no difference between
up and down options. Type B2 options are defined such that a down-and-out
call is knocked out as soon as the underlying price is below the barrier.
Similarly, an up-and-out call is knocked out as soon as the underlying price is
above the barrier. Partial-time barrier options can be priced analytically
using a model introduced by Heynen and Kat (1994).

PARTIAL-TIME-START-OUT OPTIONS: UP-AND-OUT & DOWN-AND-OUT CALLS
TYPE A

2
2
2( 1)
( )
1 1 1 3
2
2 2 2 4
( , ; ) ( , ; )
( , ; ) ( , ; )
b r T
A
rT
H
Call Se M d e M f e
S
H
Xe M d e M f e
S
q q q q
q q q q
+
(
| |
=
(
|
\ . (

(
| |

(
|
\ . (

Where

1 for an up-and-out call (C )
1 for a down-and-out call (C )
uoA
doA
q

=

2
2
1 2 1 2
2
2
2
1 2 1 2
2
2
1
1 2 1 1 3 1
1 1
2
1
4 3 1 2
2
ln( / ) ( / 2)
;
ln( / ) 2ln( / ) ( / 2)
;
ln( / ) ( / 2) 2ln( / )
; ;
/ 2
; ;
S X b T
d d d T
T
S X H S b T
f f f T
T
S H b t H S
e e e t e e
t t
t b
e e t
T
o
o
o
o
o
o
o
o
o o
o
o
o
+ +
= =
+ + +
= =
+ +
= = = +
= = =


56

PARTIAL-TIME-START-IN OPTIONS (TYPE A)

The price of "in" options of type A can be found using "out" options in
combination with plain vanilla call options computed by the Generalized
Black-Scholes formula (GBS).
Up-and-in Call
uiA GBS uoA
C Call C =
Down-and-in Call
diA GBS doA
C Call C =
PARTIAL-TIME-END-OUT OPTIONS (TYPE B)
Out Call Type B1: No difference between up-and-out and down-and-out
options

When x > H, the knock-out call value is given by:
2
1
2
2( 1)
( )
1 1 1 3
2
2 2 2 4
( , ; ) ( , ; )
( , ; ) ( , ; )
b r T
oB
rT
H
C Se M d e M f e
S
H
Xe M d e M f e
S
(
| |
=
(
|
\ . (

(
| |

(
|
\ . (

When X < H, the knock-out call value is given by:

2
1
2
2
2
2( 1)
( )
1 1 3 3
2
2 2 4 4
2( 1)
( )
1 1 1 3
2
2 2
( , ; ) ( , ; )
( , ; ) ( , ; )
( , ; ) ( , ; )
( , ; ) (
b r T
oB
rT
b r T
rT
H
C Se M g e M g e
S
H
Xe M g e M g e
S
H
Se M d e M f e
S
H
Xe M d e M
S
(
| |
=
(
|
\ . (

(
| |

(
|
\ . (

(
| |

(
|
\ . (

| |
+
|
\ .
2
2
2 4
2( 1)
( )
1 1 3 3
2
2 2 4 4
, ; )
( , ; ) ( , ; )
( , ; ) ( , ; )
b r T
rT
f e
H
Se M g e M g e
S
H
Xe M g e M g e
S
(
(

(
| |
+
(
|
\ . (

(
| |

(
|
\ . (

Where

2
2
1 2 1 2
2
3 1 4 3 2
2
ln( / ) ( / 2)
;
2ln( / )
;
S H b T
g g g T
T
H S
g g g g T
T
o
o
o
o
o
+ +
= =
= + =


57


Down-and-Out Call type B2 (case of X < H)
2
2
2
2( 1)
( )
1 1 3 3
2
2 2 4 4
( , ; ) ( , ; )
( , ; ) ( , ; )
b r T
doB
rT
H
C Se M g e M g e
S
H
Xe M g e M g e
S
(
| |
=
(
|
\ . (

(
| |

(
|
\ . (

Up-and-Out Call type B2 (case of X < H)

2
2
2
2
2
2( 1)
( )
1 1 3 3
2
2 2 4 4
2( 1)
( )
1 1 3 1
2
2 2
( , ; ) ( , ; )
( , ; ) ( , ; )
( , ; ) ( , ; )
( , ; )
b r T
uoB
rT
b r T
rT
H
C Se M g e M g e
S
H
Xe M g e M g e
S
H
Se M d e M e f
S
H
Xe M d e M
S
(
| |
=
(
|
\ . (

(
| |

(
|
\ . (

(
| |

(
|
\ . (

| |
+
|
\ .
4 2
( , ; ) e f
(

(
(


58

PAYOFFS

Call Up and Out (A) Call Down and Out (A)

Put Up and Out (A) Put Down and Out (A)

Call Out (B1) Put Out (B1)

Call Up and Out (B2) Call Down and Out (B2)

Put Up and Out (B2) Put Down and Out (B2)

0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
50 60 70 80 90 100 110 120 130 140 150
Spot

59

INSTRUMENT PRICE
Call Up and Out (A) Call Down and Out (A)

Put Up and Out (A) Put Down and Out (A)

Call Out (B1) Put Out (B1)

Call Up and Out (B2) Call Down and Out (B2)

Put Up and Out (B2) Put Down and Out (B2)
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

60

27. TWO ASSET BARRIER OPTIONS
DESCRIPTION

In a two asset barrier option, the underlying asset S1 determines how much
the option is in or out-of-the-money. The other asset S2 is the trigger asset
which is linked to barrier hits. Two-asset barrier options can be priced
analytically using a model introduced by Heynen and Kat (1994).
1 2
1 1
( )
1
2 1 2 2
3 3 2
2
2 2
2 2 4 4 2
2
( , ; )
2( ) ln( / )
exp ( , ; )
2 ln( / )
( , ; ) exp ( , ; )
b r T
rT
M d e
w S e
H S
M d e
H S
Xe M d e M d e
q | q|
q
o o
q | q|
o
q q | qu q | q|
o

= ( + `

(
)
(

` (
)

2
1 1 1
1 2 1 1
1
2 2
3 1 4 2
2 2
ln( / ) ( )
;
2 ln( / ) 2 ln( / )
;
S X T
d d d T
T
H S H S
d d d d
T T
o
o
o

o o
+ +
= =
= + = +

2 2 1 2 2
1 2 1 1 3 1
2 2
2 2 2
4 1 1 1 1 2 2 2
2
ln( / ) ( ) 2ln( / )
; ;
2ln( / )
; / 2; / 2
H S T H S
e e e T e e
T T
H S
e e b b
T
o o
o
o o
o o
o
+
= = + =
= = =

TWO-ASSET "OUT" BARRIERS
1 2
1 2
Down-and-out call (C ) 1; -1
Payoff:Max(S ; 0) if S before T else 0 at hit
Up-and-out call (C ) 1; 1
Payoff:Max(S ; 0) if S before T else 0 at hi
do
uo
X H
X H
q |
q |
= =
>
= =
<
1 2
1 2
t
Down-and-out put (P ) 1; 1
Payoff: ( ; 0) if S before T else 0 at hit
Up-and-out put (P ) 1; 1
Payoff: ( ; 0) if S before T else 0 at h
do
uo
Max X S H
Max X S H
q |
q |
= =
>
= =
< it

TWO-ASSET "IN" BARRIERS
1 2
1
Down-and-in call (C )
Payoff:Max(S ; 0) if S before T else 0 at expiration
Up-and-in call (C )
Payoff:Max(S ; 0)
di di GBS do
ui ui GBS uo
C Call C
X H
C Call C
X
=
<
=
2
1 2
if S before T else 0 at expiration
Down-and-in put (P ) P
Payoff: ( ; 0) if S before T else 0 at expiration
Up-and-in put (P ) P
di di GBS do
ui di GBS
H
Put P
Max X S H
Put P
>
=
<
=
1 2
Payoff: ( ; 0) if S before T else 0 at expiration
uo
Max X S H >


61

PAYOFFS

Payoff1= 20):







62

INSTRUMENT PRICE

the time to maturity can be represented as follows (Buying positions,
Payoff1= 20):






63

28. PARTIAL TIME TWO ASSET BARRIER OPTIONS
DESCRIPTION
Partial-time two-asset barrier options are similar to standard two-asset
barrier options, except that the barrier hits are monitored only for a fraction
of the option's lifetime. The option is knocked in or knocked out if Asset 2
hits the barrier during the monitoring period. The payoff depends on Asset 1
and the strike price. Partial-time two-asset barrier options can be priced
analytically using a model introduced by Bermin (1996).

1 2
1 1 1 2
( )
1
2 1 2 2
3 3 1 2 2
2
2 2 1 2
2 2
4 4 1 2 2
2
( , ; / )
2( ) ln( / )
exp ( , ; / )
( , ; / )
2 ln( / )
exp ( , ; / )
b r T
rT
M d e t T
w S e
H S
M d e t T
M d e t T
Xe
H S
M d e t T
q | q|
q
o o
q | q|
o
q | qu
q

q | q|
o

=
` ( +

(
)

` (

(
)
2
1 1 1 2
1 2 1 1 2
1 2
2 2
3 1 4 2
2 2 2 2
ln( / ) ( )
;
2 ln( / ) 2 ln( / )
;
S X T
d d d T
T
H S H S
d d d d
T T
o
o
o

o o
+ +
= =
= + = +
2 2 1 2 1 2
1 2 1 1 1 3 1
2 1 2 1
2 2 2
4 2 1 1 1 2 2 2
2 1
ln( / ) ( ) 2ln( / )
; ;
2ln( / )
; / 2; / 2
H S t H S
e e e t e e
t t
H S
e e b b
t
o o
o
o o
o o
o
+
= = + =
= = =

TWO-ASSET "OUT" BARRIERS
cf specification Pricer n27: TWO ASSET BARRIER OPTIONS
TWO-ASSET "IN" BARRIERS
cf specification Pricer n27: TWO ASSET BARRIER OPTIONS

64

PAYOFFS

Payoff1= 20):







65

INSTRUMENT PRICE

the time to maturity can be represented as follows (Buying positions,
Payoff1= 20):






66

29. LOOK-BARRIER OPTIONS
DESCRIPTION
A look-barrier option is the combination of a forward starting fixed strike
Lookback option and a partial time barrier option. The options barrier
monitoring period starts at time zero and ends at an arbitrary date before
expiration. If the barrier is not triggered during this period, the fixed strike
Lookback option will be kick off at the end of the barrier tenor. Lookback
barrier options can be priced analytically using a model introduced by
Bermin (1996).
A e q =
2
2
2
2
2
2 1 2 2
2
1 2
( )
2 / 2 1 2 2
1 2
1 1 1 2
1 2
2 / 1 1 1 2
1 2
, ;
1
2
2 2
, ;
, ;
2 2
, ;
n
b r T
h
rT
h
m t k T
M
t T
A Se
b
m h t h k T
e M
t T
m t k T
M
t T
e X
m h t h k T
e M
t T
o
q
q
o
q

o o
o

o o

o o

o o
( | |
+
( |
|
( | | \ .
= +
( |
| | \ . ( +
|
(
|
\ .
| |
+
|
|
\ .
| |
+

\
(
(
(
(
(
|
(
|
.

2
2
2
2
2 1
2
1 1 1 2
2
1 2
2
1 1 1 2
1 2
2 2
( ) 2 2 1
2 1
( )
, ;
2
2 2
, ;
( )
1 1
2 2
b
rT
b
b T t
b r T
m t k T S
S M
X t T
e
b
m h t h k T H
H M
X t T
T t
N e
b b T t
Se
o
q
o
q
q

o o o

o o
o o
o
(
| |
+ ( | |
|
| (
|
\ . | |
\ . (
|
(
\ .
| |
+ ( | |
|
| (
|
\ .
\ .
| |
| | | |
+ + |
|
|
\ . \
\ .
+
2
1 2
1 2 1
2 1
( )
rT
g e Xg
T t
N
T t
q

o
(
(
|
( .
(
| |
(
|
(
|
\ .

( ) Where ( ) ( ) and M ( , ; ) , ; N x N x a b M a b
q
q q q q = =
1 if up-and-out call min( , ) when 1
;
1 if down-and-out put max( , ) when 1
h k
m
h k
q
q
q
=
= =

=

2 2 1
1 2
2
ln( / ); ln( / ); / 2; / 2;
t
h H S k X S b b
T
o o = = = = + =
2 2
2 2
2 / 2 / 2 1 2 1 2 1 2 1
1
1 1 1 1
2
h h
h t h t m t m h t
g N e N N e N
t t t t
o o
q q q q

o o o o
( ( | | | | | | | |

= ( ( | | | |
| | | |
( (
\ . \ . \ . \ .
2 2
2 2
1 / 1 / 1 1 1 1 1 1 1 1
2
1 1 1 1
2
h h
h t h t m t m h t
g N e N N e N
t t t t
o o
q q q q

o o o o
( ( | | | | | | | |

= ( ( | | | |
| | | |
( (
\ . \ . \ . \ .


67

PAYOFFS


Call Up and Out Call Up and In

Put Down and Out Put Down and In


INSTRUMENT PRICE

Call Up and Out Call Up and In

Put Down and Out Put Down and In


68

30. SOFT-BARRIER OPTIONS
DESCRIPTION
A soft-barrier option is similar to a standard barrier option, except that the
barrier is no longer a single level. Rather, it is a soft range between a lower
level and an upper level. Soft-barrier options are knocked in or knocked out
proportionally. Introduced by Hart and Ross (1994), the valuation formula
can be used to price soft-down-and-in call and soft-up-and-in put options.
Soft-barrier options can be priced analytically using a model introduced by
Hart and Ross (1994).

SOFT "IN" BARRIERS
1
A
U L
e =

( )
0.5
2
1 1 2
0.5
( ) 2
0.5
2
1 1 2
0,5
2
3 2 4
0.5
2( 1)
0,5
2
3 2 4
( )
( )
2( 0.5)
( ) ( )
( ) ( )
( )
2( 0.5)
( ) ( )
b r T
rT
U
N d N d
SX
SX
A Se S
L
N e N e
SX
U
N d N d
SX
SX
Xe S
L
N e N e
SX
q q
q
q q
q q
q
q q
+
+

+
(
| |
(
|
( \ .
=
(
+
| | (
+
|
(
\ .
| |
|
\ .
| |
+
|
\ .
(
(
(
(
(
(

Where
1 if down-and-in call

1 if up-and-in put
q

=

2 2
2 2
1 2 1 3
2
4 3 1 2 1
2
3 4 3
0.5 ( 0.5)( 0.5) 0.5 ( 0.5
1 2
ln( / ( )) ln( / ( ))
; ( 0.5) ; ( 1)
ln( / ( ))
( 0.5) ; ; ( 0.5)
ln( / ( ))
( 1) ; ( 0.5)
;
T T
U SX U SX
d T d d T d T
T T
L SX
d d T e T e e T
T
L SX
e T e e T
T
e e
o o
o o o
o o
o o o
o
o o
o

( +

= + = + = +
= = + = +
= + =
= =
2
)( 1.5)
2
/ 2
;
b o
o
(

+
=

SOFT OUT BARRIERS
- Soft down-and-out call = standard call - soft down-and-in call.
- Soft up-and-out put = standard put - soft up-and-in put
Standard Calls and puts are calculated with the generalized Black scholes
formula.


69

PAYOFFS





INSTRUMENT PRICE




70

31. GAP OPTIONS
DESCRIPTION
Gap options are similar to plain options, except for the payoff. The payoff is a
function of the exercise price. The payoff on a gap option depends on all of
the factors of a plain option, but it is also affected by the gap amount, which
can be either positive or negative. A gap call option is equivalent to being
long an asset-or-nothing call and short a cash-or-nothing call. A gap put
option is equivalent to being long a cash-or-nothing put and short an asset-
or-nothing put. Gap options can be priced analytically using a model
2
1
1
( )
1 2 2
0 if S X
( ) :
if S > X
( ) ( )
b r T rT
Payoff Call
S X
Call Se N d X e N d

s
=

2
1
1
( )
2 2 1
0 if S X
( ) :
if S < X
( ) ( )
rT b r T
Payoff Put
X S
Put X e N d Se N d

>
=

Where
2
1
1 2 1
ln( / ) ( / 2)
;
S X b T
d d d T
T
o
o
o
+ +
= =
Notice that the payoff from this option can be negative, depending on the
settings of Xi and X2
PAYOFFS

INSTRUMENT PRICE


71

32. CASH-OR-NOTHING OPTIONS
DESCRIPTION

In a cash-or-nothing option, a predetermined amount is paid if the asset is, at
expiration, above for a call or below for a put some strike level, independent
of the path taken. These options require no payment of an exercise price.
Instead, the exercise price determines whether or not the option returns a
payoff. The value of a cash-or-nothing call (put) option is the present value of
the fixed cash payoff multiplied by the probability that the terminal price will
be greater than (less than) the exercise price. Cash-or-nothing options can be
priced analytically using a model introduced by Reiner and Rubinstein (1991).

0 if S K
( )
if S > K
( )
rT
Payoff Call
K
Call Ke N d
s
=

=

0 if S K
( )
if S < K
( )
rT
Payoff Put
K
Put Ke N d
>
=

=

Where
2
ln( / ) ( / 2) S X b T
d
T
o
o
+
=

PAYOFFS


INSTRUMENT PRICE


72

33. TWO ASSET CASH-OR-NOTHING OPTIONS
DESCRIPTION
Two-asset cash-or-nothing options can be useful building blocks for
constructing more complex exotic options. There are four types of two-asset
cash-or-nothing options:
1. A two-asset cash-or-nothing call pays out a fixed cash amount if
Asset 1 is above Strike 1 and Asset 2 is above Strike 2 at expiration.
2. A two-asset cash-or-nothing put pays out a fixed cash amount if
Asset 1 is below Strike 1 and Asset 2 is below Strike 2 at expiration.
3. A two-asset cash-or-nothing up-down pays out a fixed cash amount
if Asset 1 is above Strike 1 and Asset 2 is below Strike 2 at
expiration.
4. A two-asset cash-or-nothing down-up pays out a fixed cash amount
if Asset 1 is below Strike 1 and Asset 2 is above Strike 2 at
expiration.
Two-asset cash-or-nothing options can be priced analytically using a model
introduced by Heynen and Kat (1996).

Payoffs
| |
| |
| |
| |
1 1 2 2
1 1 2 2
1 1 2 2
1 1 2 2
if S and S
1 :
0 else
if S and S
2 :
0 else
if S and S
3 :
0 else
if S and S
4 :
0 else
K X X
Payoff
K X X
Payoff
K X X
Payoff
K X X
Payoff
> >
< <
> <
< >

Values
| |
| |
| |
| |
1,1 2,2
1,1 2,2
1,1 2,2
1,1 2,2
1 ( , ; )
2 ( , ; )
3 ( , ; )
4 ( , ; )
rT
rT
rT
rT
Value Ke M d d
Value Ke M d d
Value Ke M d d
Value Ke M d d
=
=
=
=

Where

2
,
ln( / ) ( / 2)
i j i i
i j
i
S X b T
d
T
o
o
+
=


73

PAYOFFS

(1)Call (asset 1) (2) Put (Asset 2)

(3)Up Down(Asset1) (4) Down Up(Asset2)


INSTRUMENT PRICE
(1)Call (asset 1) (2) Put (Asset 2)

(3)Up Down(Asset1) (4) Down Up(Asset2)


74

34. ASSET-OR-NOTHING OPTIONS
DESCRIPTION
In an asset-or-nothing option, the asset value is paid if the asset is, at
expiration, above for a call or below for a put some strike level, independent
of the path taken. The exercise price is never paid. Instead, the value of the
asset relative to the exercise price determines whether or not the option
returns a payoff. The value of an asset-or-nothing call (put) option is the
present value of the asset multiplied by the probability that the terminal
price will be greater than (less than) the exercise price. Asset-or-nothing
options can be priced analytically using a model introduced by Cox and
Rubinstein (1985).

( )
0 if S X
( )
S if S > K
( )
b r T
Payoff Call
Call Se N d
s
=

=

( )
0 if S X
( )
S if S < X
( )
b r T
Payoff Put
Put Se N d
>
=

=

Where
2
ln( / ) ( / 2) S X b T
d
T
o
o
+ +
=

PAYOFFS

INSTRUMENT PRICE

0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
50 60 70 80 90 100 110 120 130 140 150
Spot
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

75

35. SUPERSHARE OPTIONS
DESCRIPTION
A supershare is a financial instrument that represents a contingent claim on
a fraction of the underlying portfolio. The contingency is that the value of the
portfolio must lie between a lower
L
X and an upper bound
H
X on its
expiration date. If the value lies within these boundaries, the supershare is
worth a proportion of the assets underlying the portfolio, else the
supershare expires worthless. A supershare has a payoff that is basically like
a spread of two asset-or-nothing calls, in which the owner of a supershare
purchases an asset-or-nothing call with an strike price of Lower Strike and
sells an asset-or-nothing call with an strike price of Upper Strike. Supershare
options can be priced analytically using a model introduced by Hakansson
(1976).

/ if X
0 else
L L H
S X S X
Payoff
s s
=

( ) ( )
( )
1 2
( / )
b r T
L
w Se X N d N d
= (

Where
2 2
1 2
ln( / ) ( / 2) ln( / ) ( / 2)
;
L H
S X b T S X b T
d d
T T
o o
o o
+ + + +
= =

PAYOFFS
The payoff of this model can be represented as follows (buying position):

NB: "Payoff" Chart represents prices seven days before expiry, not payoff formula
INSTRUMENT PRICE
the time to maturity can be represented as follows (buying position):

0
0,2
0,4
0,6
0,8
1
1,2
1,4
1,6
1,8
2
50 60 70 80 90 100 110 120 130 140 150
Spot
0,02
0,18
0,34
0,5
0,66
0,82
0,98
0
0
0
1
1
1
1
1
2
2
2
50
60
70
80
90
100
110
120
130
140
150
Time to
Maturity
Spot

76

36. BINARY BARRIER OPTIONS
DESCRIPTION
Binary-barrier options combine characteristics of both binary and barrier
options. They are path dependent options with a discontinuous payoff.
Similar to barrier options, the payoff depends on whether or not the asset
price crosses a predetermined barrier. There are 28 different types of binary
barrier options, which can be divided into two main categories: Cash-or-
nothing and Asset-or-nothing barrier options.
Cash-or-nothing barrier options pay out a predetermined cash amount or
nothing, depending on whether the asset price has hit the barrier.
Asset-or-nothing barrier options pay out the value of the asset or nothing,
depending on whether the asset price has crossed the barrier.
The barrier monitoring frequency can be adjusted to account for discrete
monitoring using an approximation developed by Broadie, Glasserman, and
Kou (1995). Binary-barrier options can be priced analytically using a model

We begin by introducing 9 factors:
( )
( )
( )
( )
( ) ( )
( ) ( )
( ) ( )
( ) ( )
( ) ( ) ( ) ( )
( )
1 1
1 1
( )
2 2
2 2
2( 1)
( )
3 1
2
3 1
2( 1)
( )
4 2
2
4 2
5
/
/
/
/
/ / 2
b r T
rT
b r T
rT
b r T
rT
b r T
rT
A Se N x
B Ke N x T
A Se N x
B Ke N x T
A Se N H S N y
B Ke H S N y T
A Se N H S N y
B Ke H S N y T
A K H S N z H S N z T

|
| |o
|
| |o
q
q qo
q
q qo
q q qo
+
=
=
=
=
=
=
=
=
(
= +

Where K is a prespecified cash amount. The binary variables q and
| each take the value 1 or 1. Moreover:
( ) ( )
( ) ( )
1 2
2
1 2
2
2
2 2
ln( / ) ln( / )
1 ; 1
ln( / ) ln( / )
1 ; 1
ln( / ) / 2 2
; ;
S X S H
x T x T
T T
H SX H S
y T y T
T T
H S b r
z T
T
o o
o o
o o
o o
o
o
o o o
= + + = + +
= + + = + +
= + = = +

By using
1
A to
5
A and
1
B to
4
B in different combinations, we can price
the 28 binary barrier options described below :


77

Binary Barrier Options
q

|

case X>H
case
X<H
[1] Down-and-in cash-(at-hit)-or-
nothing (S>H) 1 A5 A5
[2] Up-and-in cash-(at-hit)-or-nothing
(S<H) -1 A5 A5
[3] Down-and-in asset-(at-hit)-or-
nothing (K=H) (S>H) 1 A5 A5
[4] Up-and-in asset-(at-hit)-or-nothing
(K=H)(S<H) -1 A5 A5
[5] Down-and-in cash-(at-expiry)-or-
nothing (S>H) 1 -1 B2+B4 B2+B4
[6] Up-and-in cash-(at-expiry)-or-
nothing (S<H) -1 1 B2+B4 B2+B4
[7] Down-and-in asset-(at-expiry)-or-
nothing (S>H) 1 -1 A2+A4 A2+A4
[8] Up-and-in asset-(at-expiry)-or-
nothing (S<H) -1 1 A2+A4 A2+A4
[9] Down-and-out cash-(at-expiry)-or-
nothing (S>H) 1 1 B2-B4 B2-B4
[10] Up-and-out cash-(at-expiry)-or-
nothing (S<H) -1 -1 B2-B4 B2-B4
[11] Down-and-out asset-(at-expiry)-or-
nothing (S>H) 1 1 A2-A4 A2-A4
[12] Up-and-out asset-(at-expiry)-or-
nothing (S<H) -1 -1 A2-A4 A2-A4
nothing call (S>H) 1 1 B3
B1-
B2+B4
nothing call (S<H) -1 1 B1
B2-
B3+B4
nothing call (S>H) 1 1 A3
A1-
A2+A4
Binary Barrier Options
q

|

case X>H case X<H
nothing call (S<H) -1 1 A1 A2-A3+A4
nothing put (S>H) 1 -1 B2-B3+B4 B1
nothing put (S<H) -1 -1 B1-B2+B4 B3
nothing put (S>H) 1 -1 A2-A3+A4 A1
nothing put (S<H) -1 -1 A1-A2+A3 A3
nothing call (S>H) 1 1 B1-B3 B2-B4
nothing call (S<H) -1 1 0
B1-B2+B3-
B4
nothing call (S>H) 1 1 A1-A3 A2-A4
nothing call (S<H) -1 1 0
A1-A2+A3-
A4
nothing put (S>H) 1 -1
B1-B2+B3-
B4 0
nothing put (S<H) -1 -1 B2-B4 B1-B3
nothing put (S>H) 1 -1
A1-A2+A3-
A4 0
nothing put (S<H) -1 -1 A2-A4 A1-A3


78

PAYOFFS


Down and In Cash (hit) or Nothing Up and In Cash (hit) or Nothing

Down and In Asset (hit) or Nothing Up and In Asset (hit) or Nothing


Down and In Cash (expiry) or Nothing Up and In Cash (expiry) or Nothing

Down and In Asset (expiry) or Nothing Up and In Asset (expiry) or Nothing


79

PAYOFFS


Down and Out Cash (expiry) or Nothing Up and Out Cash (expiry) or Nothing

Down and In Cash or Nothing Call Up and In Cash or Nothing Call


Down and Out Asset (expiry) or Nothing Up and Out Asset (expiry) or Nothing

Down and In Asset or Nothing Call Up and In Asset or Nothing Call


80

PAYOFFS


Down and In Cash or Nothing Put Up and In Cash or Nothing Put

Down and Out Cash or Nothing Call Up and Out Cash or Nothing Call


Down and In Asset or Nothing Put Up and In Asset or Nothing Put

Down and Out Asset or Nothing Call Up and Out Asset or Nothing Call


81

PAYOFFS


Down and Out Cash or Nothing Put Up and Out Cash or Nothing Put


Down and Out Asset or Nothing Put Up and Out Asset or Nothing Put


82

INSTRUMENT PRICE


Down and In Cash (hit) or Nothing Up and In Cash (hit) or Nothing

Down and In Asset (hit) or Nothing Up and In Asset (hit) or Nothing

Down and In Cash (expiry) or Nothing Up and In Cash (expiry) or Nothing

Down and In Asset (expiry) or Nothing Up and In Asset (expiry) or Nothing


83

INSTRUMENT PRICE


Down and Out Cash (expiry) or Nothing Up and Out Cash (expiry) or Nothing

Down and In Cash or Nothing Call Up and In Cash or Nothing Call

Down and Out Asset (expiry) or Nothing Up and Out Asset (expiry) or Nothing

Down and In Asset or Nothing Call Up and In Asset or Nothing Call


84

INSTRUMENT PRICE


Down and In Cash or Nothing Put Up and In Cash or Nothing Put

Down and Out Cash or Nothing Call Up and Out Cash or Nothing Call

Down and In Asset or Nothing Put Up and In Asset or Nothing Put

Down and Out Asset or Nothing Call Up and Out Asset or Nothing Call


85

INSTRUMENT PRICE


Down and Out Cash or Nothing Put Up and Out Cash or Nothing Put

Down and Out Asset or Nothing Put Up and Out Asset or Nothing Put


86

37. ASIAN OPTIONS 1: GEOMETRIC AVERAGE RATE OPTIONS
DESCRIPTION
Asian options are path-dependent options, with payoffs that depend on the
average price of the underlying asset or the average exercise price. There are
two categories or types of Asian options: average rate options (also known
as average price options) and average strike options. The payoffs depend on
the average price of the underlying asset over a predetermined time period.
An average option is less volatile than the underlying asset, therefore making
Asian options less expensive than standard European options. Asian options
are commonly used in currency and commodity markets. Asian options are
of interest in markets with thinly traded assets. Due to the little effect it will
have on the options value, options based on an average, such as Asian
options, have a reduced incentive to manipulate the underlying price at
expiration.

( )
1 2
( ) ( ; 0)
( ) ( )
rT
Adjusted
Average
b r T
Payoff call Max S X
Call Se N d Xe N d
=
=

( )
2 1
( ) ( ; 0)
( ) ( )
rT
Adjusted
Average
b r T
Payoff Put Max X S
Put Xe N d Se N d

=
=

Where
2
1 2 1
2
ln( / ) ( / 2)
;
1
; b
2 6 3
Adjusted Adjusted
Adjusted
Adjusted
Adjusted Adjusted
S X b T
d d d T
T
b
o
o
o
o o
o
+ +
= =
| |
= =
|
\ .

PAYOFFS

INSTRUMENT PRICE


87

38. ASIAN OPTIONS 2: THE TURNBULL AND WAKEMAN ARITHMETIC AVERAGE
APPROXIMATION

DESCRIPTION

It is not possible (or very hard) to find a closed-form solution for the value of
options on an arithmetic average. The main reason is that when the asset is
assumed to be lognormally distributed, the arithmetic average will not itself
have a lognormal distribution. Arithmetic average rate options can be priced
by the analytical approximation of Turnbull and Wakeman (1991). This
approximation adjusts the mean and variance so that they are consistent with
the exact moments of the arithmetic average. The adjusted mean,
A
b , and
variance,
2
A
o , are then used as input in the generalized BSM formula.

( )
1 2
( )
2 1
( ) ( )
( ) ( )
A
A
b r T rT
b r T rT
Call Se N d Xe N d
Put Xe N d Se N d

~
~

Where
2
1 2 1
ln( / ) ( / 2)
; d
A A
A
A
S X b T
d d T
T
o
o
o
+ +
= =
where T is the time to maturity in years.
2 1
ln( ) ln( )
2 ; b
A A A
M M
b
T T
o = =
With
2 2
1 1 1
(2 ) ( ) (2 )
1 2 2 2 2 2 2 2
1 1 1
2 2 1
; M
( ) ( )(2 )( ) ( ) 2
bt b t b T t bT b T
e e e e e
M
b T t b b T t b T t b b
o o
o o o o
+ +
(
= = +
(
+ + + +

Where
1
t is the time to the beginning of the average period.

PAYOFFS


INSTRUMENT PRICE


88

39. ASIAN OPTIONS 3: LEVY' S ARITHMETIC AVERAGE APPROXIMATION
DESCRIPTION
Levy's arithmetic average approximation (1992) is an alternative to the
Turnbull and Wakeman formula described below.
2
*
1 2
( ) ( )
rT
E
Call S N d X e N d
~
Where
| |
2 2
2
2 2
( )
*
1 2 1
* 2
2 2
(2 ) 2
2 2
( )
1 ln( )
ln( ) ;
2
; ln( ) 2 ln( ) ; D=
2 1 1
2
b r T rT
E
b
A E
b T bT
S
S e e
T
D
d X d d V
V
T T M
X X S V D rT S
T T
S e e
M
b b b
o
o o

+
=
(
= =
(

= = +
(

= (
+ +
(

The Asian put value can be found by using the following put-call parity:
2
* rT
E
Put Call S X e
= +

Where
-
A
S = Arithmetic average of the known asset price fixings.
- S = Asset price.
- X = Strike price.
- r = Risk-free interest rate.
- b = Cost-of-carry rate.
- T2 = Remaining time to maturity.
- T = Original time to maturity.
- a = Volatility of natural logarithms of return of the underlying asset.
NB : The formula does not allow for b = 0


89

PAYOFFS


INSTRUMENT PRICE


90

40. FOREIGN EQUITY OPTIONS STRUCK IN DOMESTIC CURRENCY (VALUE IN DOMESTIC
CURRENCY)
DESCRIPTION
As the name indicates, these are options on foreign equity where the strike is
denominated in domestic currency. At expiration, the foreign equity is
translated into the domestic currency. Valuation of these options is achieved
using the formula attributed to Reiner (1992).
The payoff to a European investor for an option linked to the DowJones
index is :
*
/ ( / ) ( / ) ( / )
*
/ ( / ) ( / ) ( / )
( ) ( ; 0)
( ) ( ; 0)
EUR share EUR USD USD share EUR share
EUR share EUR share EUR USD USD share
Payoff Call Max E S X
Payoff Put Max X E S
=
=

*
1 2
*
2 1
( ) ( )
( ) ( )
qT rT
rT qT
Call ES e N d Xe N d
Put Xe N d ES e N d

=
=

Where
*
*
* 2
1 2 1 *
2 2
* * * *
ln( / ) ( / 2)
;
2
ES
ES
ES
ES E S ES E S
ES X r q T
d d d T
T
o
o
o
o o o o o
+ +
= =
= + +

- S* = Underlying asset price in foreign currency.
- X = Delivery price in domestic currency.
- r = Domestic interest rate.
- q = Instantaneous proportional dividend payout rate of the
underlying asset.
- E = Spot exchange rate specified in units of the domestic currency per
unit of the foreign currency.
-
*
S
o = Volatility of the underlying asset.
-
E
o = Volatility of the domestic exchange rate.
- *
ES
= Correlation between asset and domestic exchange rate.


91

PAYOFFS


INSTRUMENT PRICE


92

41. FIXED EXCHANGE RATE FOREIGN EQUITY OPTIONS - QUANTOS (VALUE IN DOMESTIC
CURRENCY)
DESCRIPTION
A fixed exchange-rate foreign-equity option (Quanto) is denominated in
another currency than that of the underlying equity exposure. The face value
of the currency protection expands or contracts to cover changes in the
foreign currency value of the underlying asset. Quanto options can be priced
analytically using a model published by Dravid, Richardson, and Sun (1993)

*
/ ( / ) ( / ) ( / )
*
/ ( / ) ( / ) ( / )
( ) ( ; 0)
( ) ( ; 0)
EUR share P EUR USD USD share USD share
EUR share P EUR USD USD share USD share
Payoff Call E Max S X
Payoff Put E Max X S
=
=

*
*
( ) * *
1 2
( ) * *
2 1
( ) ( )
( ) ( )
f S E
f S E
r r q T rT
p
r r q T rT
p
Call E S e N d X e N d
Put E X e N d S e N d
o o
o o

(
=

(
=

Where
* *
*
* * 2
1 2 1 *
ln( / ) ( / 2)
;
f E S S
S
S
S X r q T
d d d T
T
o o o
o
o
+ +
= =

- X* = Delivery price in foreign currency.
- rf = Foreign interest rate.
underlying asset.
- Ep = Predetermined exchange rate specified in units of domestic
currency per unit of foreign currency.
- E* = Spot exchange rate specified in units of foreign currency per
unit of domestic currency.
-
*
S
-
E
o = = Volatility of the domestic exchange rate.
- = Correlation between asset and domestic exchange rate.


93

PAYOFFS


INSTRUMENT PRICE


94

42. EQUITY LINKED FOREIGN EXCHANGE OPTIONS ( VALUE IN DOMESTIC CURRENCY)
DESCRIPTION
An equity-linked foreign-exchange option is an option on the foreign
exchange rate and is linked to the forward price of a stock or equity index.
This option can be priced analytically using a model introduced by Reiner
(1992).
*
/ ( / ) ( / ) ( / )
*
/ ( / ) ( / ) ( / )
( ) ( ; 0)
( ) ( ; 0)
EUR share USD share EUR USD EUR USD
EUR share USD share EUR USD EUR USD
Payoff Call S Max E X
Payoff Put S Max X E
=
=

*
*
( ) * *
1 2
( ) * *
2 1
( ) ( )
( ) ( )
f S E
f S E
r r q T qT
r r q T qT
Call ES e N d XS e N d
Put XS e N d ES e N d
o o
o o

=
=

Where
*
2
1 2 1
ln( / ) ( / 2)
;
f E E S
E
E
E X r r T
d d d T
T
o o o
o
o
+ + +
= =
- X = Currency strike price in domestic currency.
- rf = Foreign interest rate.
underlying asset.
- E = Spot exchange rate specified in units of the domestic currency
per unit of the foreign currency.
- E* = Spot exchange rate specified in units of the foreign
- currency per unit of the domestic currency.
-
*
S
-
E
o =- Volatility of the domestic exchange rate.
- = Correlation between asset and the domestic exchange rate.


95

PAYOFFS


INSTRUMENT PRICE


96

43. TAKEOVER FOREIGN EXCHANGE OPTIONS

DESCRIPTION
A takeover foreign exchange call option gives the buyer the right to purchase
a specified number of units of foreign currency at a strike price if the
corporate takeover is successful. This option can be priced analytically using
a model introduced by Schnabel and Wei (1994).

2 1 1 2
( , ; ) ( , ; )
f
r T rT
E E
Call N Ee M a T a T Xe M a a o o

(
= +

Where
2 2
1 2
ln( / ) ( / 2) ln( / ) ( / 2)
;
f E V V f E
V E
V N r T E X r r T
a a
T T
o o o o
o o
+ +
= =
Both the strike price X and the currency price E are quoted in units of the
domestic currency per unit of the foreign currency.

PAYOFFS
The payoff of this model can be represented as follows (buying position):

INSTRUMENT PRICE
the time to maturity can be represented as follows (buying position):

97

44. EUROPEAN SWAPTIONS I N THE BLACK-76 MODEL
DESCRIPTION
A Swaption (option on Interest Rate Swap IRS) reserves the right for its
holder to purchase a swap at a prescribed time and interest rate in the
future (European Option).
The holder of such a call option has the right, but not the obligation to pay a
fixed interest rate in exchange of a variable interest rate. This option is also
known as Payer Swaption. The holder of the equivalent put option has the
right, but not the obligation to receive the fixed interest rate (Receiver
Swaption) and pay the variable interest rate.
| |
| |
1
1
1 2
2 1
1
1
(1 / )
( ) ( ) ( )
1
1
(1 / )
( ) ( ) ( )
t m
rT
t m
rT
F m
Call Payer swaption e FN d XN d
F
F m
Put Receiver swaption e XN d FN d
F
| |
|
+
\ .
=
| |
|
+
\ .
=

Where
2
1 2 1
ln( / ) ( / 2)
;
F X T
d d d T
T
o
o
o
+
= =

- t1= Tenor of swap in years; m= compounding per year
- F= Underlying Swap Rate; X =Strike Price
- T= Time to Maturity; r =Risk-free Rate;
o
= Swap Rate Volatility
PAYOFFS
The payoffs of this model can be represented as follows (for buying position):

INSTRUMENT PRICE
the time to maturity can be represented as follows (for buying positions):


98

45. THE VASICEK MODEL FOR EUROPEAN OPTIONS ON ZERO COUPON BONDS
DESCRIPTION
The Vasicek (1977) model is a yield-based one-factor equilibrium model that
assumes that the short rate is normally distributed. The model incorporates
mean reversion and is popular in the academic communitymainly due to
its analytic tractability. The model is not used much by market participants
because it is not ensured to be arbitrage-free relative to the underlying
securities already in the marketplace. This model is given by the following
general formula :
( )
z
dr k r dt d u o = +
K is the speed of the mean reversion, and u is the mean reversion level.

ZERO COUPON BOND VALUE
The price at time t of a discount bond maturing at time T is :
( , ) ( )
( , ) ( , )
B t T r t
P t T A t T e
=
Where
( )
2 2 2 2
2
1
( , )
( ( , ) )( / 2) ( , )
( , ) exp
4
T t
e
B t T
B t T T t B t T
A t T
k
k
k u o o
k k

=
( +
=
(

OPTION VALUE
The value of a European option maturing at time T on a zero-coupon bond
that matures at time t is:
( , ) ( ) ( , ) ( )
( , ) ( ) ( , ) ( )
p
p
Call P t N h XP t T N h
Put XP t T N h P t N h
t o
o t
=
= +

Where r(t) is the rate at time t and
2 2 ( )
1 ( , )
ln
( , ) 2
(1 )
( , )
2
P
P
T t
P
P t
h
P t T X
e
B t
k
o t
o
o
o t
k

(
= +
(

=


99

PAYOFFS


INSTRUMENT PRICE

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