compound option

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Compound option

Option on an option.

Compound Option

An option contract on an option contract. There are four basic types: a call on a call; a put on a call; a call on a put; and a put on a put. A compound option has two expiration dates and two strikes. There are also two premiums: one paid up front and the other paid if the underlying option is exercised. It is often used in markets where there are doubts on the risk for the underlying option, such as currency or fixed income markets. It is also called a split-fee option.

compound option

An option to purchase an option. Examples include, a call on a call option or a call on a put option. A fee must be paid to buy a compound option and a second payment must be made to the owner of the option in the event the compound option is exercised. Also called split-fee option. See also back fee, front fee.
References in periodicals archive ?
This paper examines the empirical performance of various option-pricing models in hedging exotic options, such as barrier options and compound options.
Second, the test is based upon the performance of the models in hedging exotic options, such as barrier options and compound options.
In other words, barrier options are further away from European options than compound options in terms of their payoff structures.
Compound options generate other options among exercise.
A first example of compound options can be found in a staged investment, which may be assimilated to a sequence of stages where each stage is contingent on the completion of its predecessor.
In addition to options to defer, expand, extend, contract, or abandon projects, there are also switching options; compound options, which are options on options; and rainbow options, which embody several types of uncertainty.
Almost all capital expenditure decisions are phased investments, and all phased investments are compound options.
Mondher Bellalah presents a simple framework for the valuation of compound options within a context of incomplete information.
8 These options are, in fact, options on options, or compound options (see Geske |5~).
Another possibility is to model the first years of production as compound options, which would increase complexity substantially.
This paper presents a simple framework for the valuation of compound options within a context of incomplete information.
They show that corporate investment opportunities may be analyzed as options and compound options.