compound option

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Compound option

Option on an option.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

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.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

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.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.
References in periodicals archive ?
Such a valuation is based on the generalisation of a compound options pricing model.
Geske, "The valuation of compound options," Journal of Financial Economics, vol.
It will be easy to make out team strategy however as the different tyre compound options will be clearly colour coded - the colour of the Pirelli PZERO logo on the tyre will be red for super soft,yellow for soft, white for medium, silver for hard, light blue for intermediates and orange for wets.
This paper examines the empirical performance of various option-pricing models in hedging exotic options, such as barrier options and compound options. A practical and relevant testing approach is adopted to capture the essence of model risk in option pricing and hedging.
We show how these options can be valued as portfolios of standard and compound options written on the stock of an otherwise similar company without warrants and derive a closed-form solution for the Black-Scholes model.
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.
In this article, we focus at first on compound options: those that when exercised generate another option, as well as a cash flow.
Compound options generate other options among exercise.
For instance, "Compound options" are options on options--typically options at various stages in the life of a project; "rainbow options" are driven by multiple sources of uncertainty such as price of a unit of output, quantity that might be sold, and interest-rate variability; and "compound rainbow options" are options on options with multiple sources of uncertainty at each decision stage.
The seven basic real options can also occur in combinations, as compound options. A company that invests in an R&D project, say, may be buying both the option to commercialize the resulting product and the option to engage in subsequent R&D projects to develop future generations of related products.
Thus, each stage (e.g., building necessary infrastructure) can be viewed as an option on the value of subsequent stages by incurring the installment cost outlay (e.g., |I.sub.1~) required to proceed to the next stage, and can therefore be valued similar to compound options. This option is valuable in all R&D intensive industries, especially pharmaceuticals, in highly uncertain, long-development capital intensive industries, such as energy-generating plants or large-scale construction, and in venture capital.
Mondher Bellalah presents a simple framework for the valuation of compound options within a context of incomplete information.