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:

a short note

Antonie Kotz´ e and Angelo Joseph

‡

May 2009

Financial Chaos Theory, Johannesburg, South Africa

Mail: consultant@quantonline.co.za

Abstract

In this note we discuss and summarize the valuation methodology

for Double Barrier Cash or Nothing Options. We start oﬀ by brieﬂy

deﬁning vanilla binary options and ordinary and double barrier op-

tions. We then move on to the valuation and price dynamics of the

option at hand. After that we list the formulas for the Greeks and

discuss their dynamics. Lastly we take a look at the asymptotes if one

of the barriers disappears or falls away.

‡

We want to thank the JSE (especially Safex) in Johannesburg, South Africa for their

assistance in the preparation of this note.

1 Binary Options

A binary option is a type of option where the payoﬀ is discontinuous in the

underlying asset – it is either some ﬁxed amount of some asset or nothing at

all

1

. The two main types of binary options are the cash-or-nothing and the

asset-or-nothing options [Wi98]. The cash-or-nothing option pays some ﬁxed

amount of cash if the option expires in-the-money whilst the asset-or-nothing

pays the value of the underlying security. The payoﬀs of these options are

binary in nature because there can only be two possible outcomes [RR91b].

These options are also known as digital options.

Binary options are used as a hedge against “jump risk” e.g., where the

underlying asset is illiquid and as such the price can suddenly jump to an-

other level. They are generally simpler to trade because they require only

a sense of direction of the price movement of the underlying asset, whereas

traditional options require a sense of direction as well as the magnitude of

the price movement. The biggest advantage of binary options is that they

have a controlled risk to reward ratio, meaning the risk and reward are pre-

determined at the time the contract is acquired. Due to this they are widely

used in the sports betting industry.

2 Barrier Options

European, continuously-monitored barrier options are European options with

an American feature. Option’s existence depends on whether the underlying

price breaches, before or at maturity, some pre-speciﬁed level, called a bar-

rier [Sb00]. These options are standard calls and put except that they either

disappear (the option is knocked out) or appear (the option is knocked in) if

the underlying asset price breach a predetermined level (the barrier) [RR91a].

Barrier options are thus conditional options, dependent on whether the bar-

riers have been crossed within the lives of the optionscitekn:Ko98. These

options are also part of a class of options called path-dependent options

2,3

.

Barrier options are usually cheaper than their vanilla counterparts [Ya03].

This is due to the fact that a buyer of a barrier option has a more speciﬁc

1

The term “binary” comes from the computer or mathematics jargon: a binary number

is one which is given a value of either 0 or 1 and nothing else. Applying that terminology, a

binary option is an option that, at expiration, can have only one of two payoﬀ possibilities,

a 0 or a 1.

2

A path-dependent option is an option whose payoﬀ depends on the history of the

underlying asset price.

3

Other path-dependent options are Asian options, look-back options, ladder options

and chooser or shout options.

1

view of the underlying asset price dynamics within the time to maturity of

the option [Zh98]. These options are also called single barrier options. Note

that a portfolio of a knock-in and a knock-out written on the same barrier

and strike is equivalent to a vanilla option with the same strike.

Another hybrid to the barrier family is the so-called partial time barrier

option. Here, the barrier is monitored (or active) for a time period that is

shorter than the expiry time [St07]. These options are also called window

barrier options [Zh98].

Another reﬁnement is where the barrier is monitored discretely in time.

Most traded barriers are monitored daily using the oﬃcial close price of

the underlying asset. Broadie, Glasserman and Kou studied this and solved

the problem. They connected the continuous- and discrete time monitored

barrier options by making an adjustment to the barrier level [BG99].

Another style of barrier option is the double barrier. Here there is both

an upper and a lower barrier, the ﬁrst above and second below the current

asset price. Double knock-ins come to life and double knockouts terminate

if either barrier is hit [Ha07].

Via double barriers, investors enjoy even greater leverage potential: single

knock-outs typically have barriers too close for comfort and single knock-ins

have less knock-in chances without much discount. A double knock-in may

be bought by a fund manager who bets against market consensus’ direction

but hedges her bet for marking-to-market purposes. It may also be bought

by a trader who foresees a bigger volatility than the market consensus’ one

in both bullish and bearish scenarios [Sb00].

3 Double Barrier Binary Options

A step further along the option evolution path is where we combine barrier

and binary options to obtain “binary barrier options”. There are 28 vari-

ants [RR91a, Ha07]. Taking this another step further, we combine a double

barrier with a binary option. These double barrier binary options are not

combinations of single barrier binary options. Hui discussed the pricing of

the cash or nothing variants in a Black & Scholes environment [Hu96]. There

are only two types: knock-outs and knock-ins.

2

3.1 Option Valuation

Deﬁnition 3.1 Double Barrier Cash or Nothing Knock-Out (dbcnko) op-

tion:

The option pays zero (expires worthless) if the underlying price S touches

either the lower barrier B

L

or the upper barrier B

U

, during the lifetime T of

the option. However, it pays a pre-deﬁned cash amount R at expiry if neither

of the barriers are hit during the lifetime of the option.

♠

This option is quite simple because we do not have to specify a strike

price - the barriers act as the triggers whether it will pay out or not.

Intuitively, we can claim that the value of the knock-out option is the

probability of the underlying price S staying within the barriers during the

option’s lifetime. The upper and lower barriers deﬁne a boundary range.

Using the Fourier sine series

4

, we can show that the risk-neutral value of a

Double Barrier Cash or Nothing Knock-Out is [Hu96, Ha07]

V

dbcnko

=

∞

i=1

2π i R

Z

2

_

¸

_

_

S

B

L

_

α

+ (−1)

i+1

_

S

B

U

_

α

α

2

+

_

iπ

Z

_

2

_

¸

_

× sin

_

iπ

Z

ln

_

S

B

L

__

× e

−

1

2

_

(

iπ

Z

)

2

−β

_

σ

2

T

(1)

where

Z = ln

_

B

U

B

L

_

, α =

d −r

σ

2

+

1

2

, β = −

1

4

_

2 (r −d)

σ

2

−1

_

2

−2

r

σ

2

.

We deﬁne r to be the risk-free rate in continuous format, d the dividend yield

in continuous format and σ is the annualised underlying’s price volatility.

In Figure 3.1 we give a VBA function to implement this option in Excel.

Hui showed that the series in Eq. (1) converges quite quickly. Our tests

show that n = 100 gives good results in all circumstances: where the barriers

are close to the spot price and when T is very small. Table (3.1) shows the

dynamics of the option price with respect to S and time to expiry. This

clearly shows that the option value diminishes the closer we are to one of

the barriers but it gyrates towards the cash payout R when we are close to

expiry and far from the barriers.

4

The sine trigonometric is a periodic function with waves bounded by the amplitude.

It therefore makes sense to use the Fourier sine series in the pricing of these options.

3

Function double_cash_nothing(S As Double, Bu As Double, Bl As Double, _

Rebate As Double, r As Double, _

sigma As Double, T As Double, _

d As Double) As Double

’ Knock-Out: if either barrier is hit, pays nothing. If not, pays rebate

’ Knock-in: if either barrier is hit, pays rebate, if not, pays nothing

’ S = spot price

’ Bu = upper barrier; Bl = lower barrier

’ r = interest rate in continuous format

’ d = dividend yield in continuous format

’ sigma = volatility

’ T = annualised time to expiry

’ Rebate = cash to pay out

Pi=3.14159265358979

If (T < 0) Then

SOM = 0

ElseIf S >= Bu Or S <= Bl Then

’ Option knocked out

SOM = 0

Else

Alfa = -0.5 * (2 * (rd - d) / sigma / sigma - 1)

Beta = -0.25 * (2 * (rd - d) / sigma / sigma - 1) ^ 2 - _

2 * rd / sigma / sigma

Z = Log(Bu / Bl)

SOM = 0

For i = 1 To 100

SOM = SOM + 2 * Pi * i * Rebate / Z / Z _

* (((S / Bl) ^ Alfa - (-1) ^ i * (S / Bu) ^ Alfa) / _

(Alfa * Alfa + (i * Pi / Z) ^ 2)) _

* Sin(i * Pi / Z * Log(S / Bl)) * _

Exp(-0.5 * ((i * Pi / Z) ^ 2 - Beta) * sigma * sigma * T)

Next

End If

double_cash_nothing = SOM

End Function

Figure 1: VBA code to implement Eq. (1).

4

Time\

Spot 85.5 90 92.5 95 97.5 100 102.5 105 107.5 110 114.5

0.5041 2.64 24.34 33.51 39.86 43.14 43.33 40.63 35.43 28.21 19.51 1.98

0.4192 4.67 42.96 59.16 70.38 76.16 76.49 71.74 62.56 49.80 34.44 3.50

0.3370 8.09 74.47 102.55 121.99 132.02 132.59 124.36 108.44 86.32 59.71 6.07

0.2521 14.29 131.49 181.05 215.38 233.08 234.09 219.55 191.44 152.40 105.41 10.72

0.1671 25.23 232.19 319.68 380.27 411.49 413.27 387.58 337.96 269.04 186.09 18.93

0.0849 44.25 405.32 555.68 658.52 710.96 713.82 670.51 586.37 468.39 324.97 33.14

0.0027 250.95 997.98 999.79 999.79 999.79 999.79 999.79 999.79 999.56 984.57 188.08

Table 1: Price dynamics of an option with T = 0.5041. The stock price is

100, the payout R1000, the volatility 35%, the riskfree rate 8% (naca) and

dividend yield is 2% (naca).

The knock-in counterpart can be valued as a short Double Barrier Cash

or Nothing Knock-Out plus the discounted cash payout R [Ha07]. It is given

by

V

dbcnki

= Re

−rT

−V

dbcnko

(2)

3.2 Hedge Parameters

The delta of V

dbcnko

is obtained by taking the ﬁrst derivative of Eq. (1) with

respect to the underlying price S such that

∆

dbcnko

=

∂V

dbcnko

∂S

=

∞

i=1

2π i R

S Z

2

_

¸

_

_

S

B

L

_

α

+ (−1)

i+1

_

S

B

U

_

α

α

2

+

_

iπ

Z

_

2

_

¸

_

_

_

iπ

Z

tan

_

iπ

Z

ln

S

B

L

_

+ α

_

_

× sin

_

iπ

Z

ln

S

B

L

_

e

−

1

2

_

(

iπ

Z

)

2

−β

_

σ

2

T

(3)

Table (3.2) shows the dynamics of the delta with respect to the underlying

price S and time to maturity for the same option shown in Table (3.1). We

calculate the Vega (volatility risk) numerically by bumping the volatility up

by 1%. The Vega dynamics for the same option shown above is given in

Table 3.2.

The risk parameters for the Knock-In can be obtained from Eq. (2) such

that

∆

dbcnki

= −∆

dbcnko

Γ

dbcnki

= −Γ

dbcnko

V ega

dbcnki

= −V ega

dbcnko

.

5

Time\

Spot 85.5 90 92.5 95 97.5 100 102.5 105 107.5 110 114.5

0.5041 5.27 4.17 3.13 1.93 0.69 -0.52 -1.61 -2.52 -3.22 -3.70 -3.97

0.4192 9.30 7.36 5.53 3.42 1.21 -0.92 -2.84 -4.45 -5.69 -6.53 -7.02

0.3370 16.12 12.76 9.58 5.92 2.10 -1.59 -4.92 -7.71 -9.86 -11.31 -12.16

0.2521 28.46 22.53 16.92 10.45 3.70 -2.81 -8.69 -13.62 -17.41 -19.97 -21.47

0.1671 50.26 39.78 29.87 18.44 6.53 -4.97 -15.34 -24.04 -30.74 -35.25 -37.90

0.0849 88.13 68.78 50.98 31.10 10.91 -8.39 -25.90 -40.94 -52.88 -61.22 -66.37

0.0027 483.64 3.73 0.01 0.00 0.00 -0.00 -0.00 -0.00 -0.46 -20.82 -369.87

Table 2: Dynamics of the Delta of an option with T = 0.5041. The stock

price is 100, the payout R1000, the volatility 35%, the riskfree rate 8% (naca)

and dividend yield is 2% (naca).

Time\

Spot 85.5 90 92.5 95 97.5 100 102.5 105 107.5 110 114.5

0.5041 -0.47 -4.33 -5.94 -7.04 -7.60 -7.61 -7.11 -6.18 -4.91 -3.39 -0.34

0.4192 -0.71 -6.47 -8.87 -10.51 -11.34 -11.34 -10.60 -9.21 -7.31 -5.04 -0.51

0.3370 -1.01 -9.19 -12.59 -14.90 -16.05 -16.04 -14.98 -13.00 -10.30 -7.10 -0.72

0.2521 -1.36 -12.40 -16.96 -20.05 -21.55 -21.51 -20.05 -17.38 -13.75 -9.45 -0.95

0.1671 -1.65 -14.93 -20.35 -23.96 -25.68 -25.54 -23.74 -20.52 -16.19 -11.10 -1.11

0.0849 -1.66 -14.33 -18.82 -21.42 -22.44 -22.16 -20.77 -18.29 -14.75 -10.30 -1.04

0.0027 -6.86 -0.61 -0.00 -0.00 -0.00 -0.00 -0.00 -0.00 -0.11 -3.05 -5.04

Table 3: Dynamics of the Vega of an option with T = 0.5041. The stock

price is 100, the payout R1000, the volatility 35%, the riskfree rate 8% (naca)

and dividend yield is 2% (naca).

3.3 Asymptotes of the Double Barrier Binary Option

If the lower barrier, B

L

is much lower than the underlying price S, the

presence of that barrier becomes insigniﬁcant. The Double Barrier Cash or

Nothing Knock-Out option then approaches the value of the single barrier

Up-and-Out Cash-or-Nothing Put (kocn) with a rebate R with both barrier

and strike at the upper barrier B

U

. In short,

lim

B

L

→ 0

V

dbcnko

∼

= V

kocn

with strike K ≈ B

U

.

The pricing formula for this option is due to Reiner and Rubinstein

[RR91b] (also see [Ha07])

V

kocn

= R e

−rτ

_

N

_

φx

1

−φσ

√

T

_

−

_

B

S

_

2µ

N

_

ηy

1

−ησ

√

T

_

_

(4)

where

x

1

=

1

σ

√

τ

ln

_

S

K

_

+ (µ + 1)σ

√

T

6

y

1

=

1

σ

√

τ

ln

_

B

2

S K

_

+ (µ + 1)σ

√

T

λ =

¸

µ

2

+

2 r

σ

2

µ =

r −d

σ

2

−

1

2

and N(•) is the cumulative normal distribution function (see [Ha07]), K is

the strike price , B the barrier level and R is the cash payout. To price the

Up-and-Out Cash-or-Nothing Put we must use

φ = η = −1; B = K = B

U

.

Values obtained from the formulas in Eqs (1) and (4) converge if the lower

barrier level is very small in Eq (1) - a lower barrier 1% of the spot price,

will suﬃce.

If the upper barrier is signiﬁcantly higher than the underlying price S,

the Double Barrier Cash or Nothing Knock-Out option approaches the value

of the Down-and-Out Cash-or-Nothing Call (docn) with both barrier and

strike at the lower barrier B

L

. The value of this option is given by Eq. (4)

where we have

φ = η = 1; B = K = B

L

.

References

[BG99] M. Broadie, P. Glasserman & S.G. Kou, Connecting discrete and

continuous path-dependent options, Finance Stochastics, 3,(1999)

[Ha07] E. G. Haug, Option Pricing Formulas, 2

nd

Edition, McGraw-Hill

Companies (2007).

[Hu96] C. H. Hui, One-Touch Barrier Binary Option Values, Applied Finan-

cial Economics, 6, 343-346 (1996)

[Ko99] A. A. Kotz´e, Barrier Options Traded in the South African Markets,

Financial Chaos Theory Working paper, (1999)

[RR91a] E. Reiner & M. Rubinstein Breaking Down the Barriers, Risk, 4.

(September 1991)

7

[RR91b] E. Reiner & M. Rubinstein, Unscrambling the Binary Code, Risk,

4. (October 1991)

[Sb00] Alessandro Sbuelz, Hedging Double Barriers With Singles, Working

paper, Tilburg University (2001)

[St07] J. Stoklosa, Studies of Barrier Options and their Sensitivities, Univer-

sity of Melbourne, Department of Mathematics and Statistics, Hon-

ours Thesis (2007)

[Wi98] P. Wilmott, Derivatives: the theory and practice of ﬁnancial engi-

neering, Wiley (1998)

[Ya03] Tung, Ya-Ching, Pricing Parisian-Type Options, A Thesis Submitted

to the Graduate Institute of Finance in the Management School of the

National Taiwan University in Partial Fulﬁlment of the Requirement

for the Degree of Master of Science (June 2003)

[Zh98] P. G. Zhang, Exotic Options: A Guide to Second Generation Options,

2

nd

Edition, World Scientiﬁc (1998)

No part of this work may be reproduced in any form or by any means without Financial Chaos Theory’s

written permission. Whilst all care is taken by Financial Chaos Theory’s (PTY) LTD to ensure that

all information in this document is accurate, no warranty is given as to its completeness and reliability,

and persons who rely on it do so at their own risk. FCT does not accept any responsibility for errors or

omissions.

8

Barrier options are thus conditional options. a binary option is an option that. before or at maturity. 1 1 . called a barrier [Sb00]. Barrier options are usually cheaper than their vanilla counterparts [Ya03].1 Binary Options A binary option is a type of option where the payoﬀ is discontinuous in the underlying asset – it is either some ﬁxed amount of some asset or nothing at all1 . a 0 or a 1. Due to this they are widely used in the sports betting industry. where the underlying asset is illiquid and as such the price can suddenly jump to another level. 2 Barrier Options European. They are generally simpler to trade because they require only a sense of direction of the price movement of the underlying asset. The cash-or-nothing option pays some ﬁxed amount of cash if the option expires in-the-money whilst the asset-or-nothing pays the value of the underlying security. The two main types of binary options are the cash-or-nothing and the asset-or-nothing options [Wi98]. ladder options and chooser or shout options.3 . at expiration. some pre-speciﬁed level.. look-back options. 2 A path-dependent option is an option whose payoﬀ depends on the history of the underlying asset price. These options are also known as digital options.g. These options are standard calls and put except that they either disappear (the option is knocked out) or appear (the option is knocked in) if the underlying asset price breach a predetermined level (the barrier) [RR91a]. The biggest advantage of binary options is that they have a controlled risk to reward ratio. Binary options are used as a hedge against “jump risk” e. Option’s existence depends on whether the underlying price breaches. This is due to the fact that a buyer of a barrier option has a more speciﬁc The term “binary” comes from the computer or mathematics jargon: a binary number is one which is given a value of either 0 or 1 and nothing else. whereas traditional options require a sense of direction as well as the magnitude of the price movement. continuously-monitored barrier options are European options with an American feature. Applying that terminology. meaning the risk and reward are predetermined at the time the contract is acquired. The payoﬀs of these options are binary in nature because there can only be two possible outcomes [RR91b]. dependent on whether the barriers have been crossed within the lives of the optionscitekn:Ko98. 3 Other path-dependent options are Asian options. can have only one of two payoﬀ possibilities. These options are also part of a class of options called path-dependent options2.

Broadie. There are only two types: knock-outs and knock-ins. Taking this another step further. Here there is both an upper and a lower barrier. There are 28 variants [RR91a. Another style of barrier option is the double barrier. Another reﬁnement is where the barrier is monitored discretely in time. Another hybrid to the barrier family is the so-called partial time barrier option. investors enjoy even greater leverage potential: single knock-outs typically have barriers too close for comfort and single knock-ins have less knock-in chances without much discount. the ﬁrst above and second below the current asset price. Most traded barriers are monitored daily using the oﬃcial close price of the underlying asset. It may also be bought by a trader who foresees a bigger volatility than the market consensus’ one in both bullish and bearish scenarios [Sb00].and discrete time monitored barrier options by making an adjustment to the barrier level [BG99]. They connected the continuous. Ha07]. These options are also called window barrier options [Zh98]. These double barrier binary options are not combinations of single barrier binary options. 2 .view of the underlying asset price dynamics within the time to maturity of the option [Zh98]. Note that a portfolio of a knock-in and a knock-out written on the same barrier and strike is equivalent to a vanilla option with the same strike. Glasserman and Kou studied this and solved the problem. These options are also called single barrier options. Via double barriers. Hui discussed the pricing of the cash or nothing variants in a Black & Scholes environment [Hu96]. we combine a double barrier with a binary option. the barrier is monitored (or active) for a time period that is shorter than the expiry time [St07]. Double knock-ins come to life and double knockouts terminate if either barrier is hit [Ha07]. Here. 3 Double Barrier Binary Options A step further along the option evolution path is where we combine barrier and binary options to obtain “binary barrier options”. A double knock-in may be bought by a fund manager who bets against market consensus’ direction but hedges her bet for marking-to-market purposes.

it pays a pre-deﬁned cash amount R at expiry if neither of the barriers are hit during the lifetime of the option. during the lifetime T of the option.1) shows the dynamics of the option price with respect to S and time to expiry. In Figure 3. Hui showed that the series in Eq.1 we give a VBA function to implement this option in Excel.3. we can show that the risk-neutral value of a Double Barrier Cash or Nothing Knock-Out is [Hu96. (1) converges quite quickly. The sine trigonometric is a periodic function with waves bounded by the amplitude. It therefore makes sense to use the Fourier sine series in the pricing of these options.1 Option Valuation Deﬁnition 3. BL α= d−r 1 + .the barriers act as the triggers whether it will pay out or not. Intuitively. This clearly shows that the option value diminishes the closer we are to one of the barriers but it gyrates towards the cash payout R when we are close to expiry and far from the barriers. ♠ This option is quite simple because we do not have to specify a strike price . 4 3 . Table (3. However. Our tests show that n = 100 gives good results in all circumstances: where the barriers are close to the spot price and when T is very small. we can claim that the value of the knock-out option is the probability of the underlying price S staying within the barriers during the option’s lifetime.1 Double Barrier Cash or Nothing Knock-Out (dbcnko) option: The option pays zero (expires worthless) if the underlying price S touches either the lower barrier BL or the upper barrier BU . d the dividend yield in continuous format and σ is the annualised underlying’s price volatility. σ2 2 β=− 1 4 2 (r − d) −1 σ2 2 −2 r . Using the Fourier sine series4 . The upper and lower barriers deﬁne a boundary range. σ2 We deﬁne r to be the risk-free rate in continuous format. Ha07] Vdbcnko 2π i R = 2 i=1 Z × sin ∞ S BL α + (−1)i+1 α2 + × e iπ Z −1 2 2 S BU α iπ S ln Z BL ( iπ ) Z 2 − β σ2 T (1) where Z = ln BU .

14159265358979 If (T < 0) Then SOM = 0 ElseIf S >= Bu Or S <= Bl Then ’ Option knocked out SOM = 0 Else Alfa = -0.25 * (2 * (rd .5 * ((i * Pi / Z) ^ 2 . T As Double. pays rebate. If not. _ Rebate As Double. pays nothing._ 2 * rd / sigma / sigma Z = Log(Bu / Bl) SOM = 0 For i = 1 To 100 SOM = SOM + 2 * Pi * i * Rebate / Z / Z _ * (((S / Bl) ^ Alfa . Bl As Double.1) ^ 2 . pays rebate ’ Knock-in: if either barrier is hit.5 * (2 * (rd .d) / sigma / sigma .d) / sigma / sigma . pays nothing ’ S = spot price ’ Bu = upper barrier. (1).(-1) ^ i * (S / Bu) ^ Alfa) / _ (Alfa * Alfa + (i * Pi / Z) ^ 2)) _ * Sin(i * Pi / Z * Log(S / Bl)) * _ Exp(-0. 4 . _ sigma As Double. Bu As Double. if not.Function double_cash_nothing(S As Double. _ d As Double) As Double ’ Knock-Out: if either barrier is hit. r As Double.Beta) * sigma * sigma * T) Next End If double_cash_nothing = SOM End Function Figure 1: VBA code to implement Eq. Bl = lower barrier ’ r = interest rate in continuous format ’ d = dividend yield in continuous format ’ sigma = volatility ’ T = annualised time to expiry ’ Rebate = cash to pay out Pi=3.1) Beta = -0.

36 219.96 74.47 131.44 191. the volatility 35%.79 100 43.09 324.39 999.98 92.33 76.3370 0.56 110 19.0027 85.51 59.99 215.40 269.79 95 39.27 658.86 70.5 1.34 42.64 4.16 102.5 2.44 337.57 114.04 468.21 49.5 33.79 97.49 232.5 40. 5 .05 319. It is given by Vdbcnki = R e−rT − Vdbcnko (2) 3.2521 0.27 713.23 44. The knock-in counterpart can be valued as a short Double Barrier Cash or Nothing Knock-Out plus the discounted cash payout R [Ha07].32 997.79 105 35.68 999.4192 0.41 186.2) shows the dynamics of the delta with respect to the underlying price S and time to maturity for the same option shown in Table (3.14 188. (2) such that ∆dbcnki = −∆dbcnko Γdbcnki = −Γdbcnko V egadbcnki = −V egadbcnko .09 14.1671 0.0849 0. (1) with respect to the underlying price S such that ∆dbcnko = ∂Vdbcnko ∂S ∞ 2π i R = 2 i=1 S Z S BL α + (−1) α2 + i+1 2 S BU α iπ Z 2 tan iπ Z iπ S ln BL Z + α (3) iπ S × sin ln Z BL e −1 2 ( iπ ) Z −β σ 2 T Table (3.Time\ Spot 0.1).08 Table 1: Price dynamics of an option with T = 0. the riskfree rate 8% (naca) and dividend yield is 2% (naca). The Vega dynamics for the same option shown above is given in Table 3.79 102.59 234.95 90 24.79 107.80 86.38 121.63 71.5 28.52 999.67 8.2 Hedge Parameters The delta of Vdbcnko is obtained by taking the ﬁrst derivative of Eq.51 999.96 999.98 3.38 380.49 132.82 999.43 62.50 6.58 670. The stock price is 100.16 132.14 76.51 34. We calculate the Vega (volatility risk) numerically by bumping the volatility up by 1%.25 250. The risk parameters for the Knock-In can be obtained from Eq.5 43.08 411.19 405.32 152.71 105.49 710.37 999.55 181.72 18.5041 0.02 233.93 33.68 555.97 984.07 10.5041.56 108.96 586. the payout R1000.55 387.29 25.74 124.44 59.2.09 413.

5041. Time\ Spot 0.98 -20.69 -9.39 -0.40 -14.94 -8.71 -1.33 -6.92 10.44 31.05 -23.27 9.21 -13.97 -7.10 3.44 -0.1671 0.97 -8.37 -369.61 -2.18 -9.5 -0.51 -0.78 68.34 -16.86 90 -4.5 -1.82 -0.46 110 -3.Time\ Spot 0.00 107.38 -20. BL → 0 lim Vdbcnko ∼ Vkocn = with strike K ≈ BU . The pricing formula for this option is due to Reiner and Rubinstein [RR91b] (also see [Ha07]) Vkocn = R e where x1 = 1 S √ ln σ τ K 6 √ + (µ + 1)σ T −rτ B N φx1 − φσ T − S √ 2µ √ N ηy1 − ησ T (4) .22 -5.5 -4.04 -10.75 -0.16 -21.04 -40.00 102.4192 0.19 -14.25 -61.58 16.5 0.64 90 4.92 -1.90 -0.84 -4.00 95 -7.77 -0.5041 0.93 -14.45 -11.76 22.13 5.00 105 -6.04 -7.52 -18.1671 0.71 -13.01 95 1.60 -14.05 -23.53 -11.59 -16.74 -20.46 50.0027 85.22 -20.26 88.31 -10.30 -13.11 -10.00 97.96 -21.5 -3.66 -6. BL is much lower than the underlying price S.61 92.11 -1.00 105 -2.53 9.47 -9.30 -3. the riskfree rate 8% (naca) and dividend yield is 2% (naca).00 97.82 114.68 -22.05 -21.00 100 -7.5 -7.78 3.94 -0.55 -25.54 -22.34 -16.19 -12.10 0.81 -4.01 -1.17 7.87 Table 2: Dynamics of the Delta of an option with T = 0. the payout R1000.98 0.59 -2.72 -0.51 -25.91 -7.5041.5 -5.04 Table 3: Dynamics of the Vega of an option with T = 0. the volatility 35%.0027 85.31 -19.96 -20.00 -17.34 -0.36 -1.87 50.52 -4.88 -0.92 -8. 3. the volatility 35%. In short.65 -1.4192 0.90 -66.36 12.00 107.62 -24.16 -0.02 -12.69 -15.74 -52.86 -17.60 -11. The Double Barrier Cash or Nothing Knock-Out option then approaches the value of the single barrier Up-and-Out Cash-or-Nothing Put (kocn) with a rebate R with both barrier and strike at the upper barrier BU .87 -12.51 -14.00 102.35 -18.34 -25.30 16.33 -0. the payout R1000.5 5.97 -35.41 -30.52 -0.5 -3.11 110 -3.3370 0.12 28.70 6.29 -0.0849 0.13 483. The stock price is 100.61 -11.2521 0.53 39.00 100 -0. The stock price is 100. the presence of that barrier becomes insigniﬁcant.39 -5.10 -10.93 3.75 -16.5041 0.2521 0.5 -7.3370 0.5 3.42 -0.21 2.70 -6.92 29.53 10.0849 0.04 -5.42 5.73 92.47 -0.47 -37.04 -21.45 -7.10 -9.95 -1.69 1.05 114.3 Asymptotes of the Double Barrier Binary Option If the lower barrier.45 18.90 -20.91 0. the riskfree rate 8% (naca) and dividend yield is 2% (naca).5 -0.

Finance Stochastics. Rubinstein Breaking Down the Barriers. B = K = BL . To price the Up-and-Out Cash-or-Nothing Put we must use φ = η = −1. One-Touch Barrier Binary Option Values. Values obtained from the formulas in Eqs (1) and (4) converge if the lower barrier level is very small in Eq (1) . Connecting discrete and continuous path-dependent options. Applied Financial Economics. [Hu96] C. Broadie. If the upper barrier is signiﬁcantly higher than the underlying price S. P. Glasserman & S. (September 1991) 7 . (1999) [RR91a] E. K is the strike price . Hui. (4) where we have φ = η = 1. H.a lower barrier 1% of the spot price. Financial Chaos Theory Working paper. Kou.(1999) [Ha07] E. 4. B = K = BU . Reiner & M. B the barrier level and R is the cash payout. the Double Barrier Cash or Nothing Knock-Out option approaches the value of the Down-and-Out Cash-or-Nothing Call (docn) with both barrier and strike at the lower barrier BL . A. Kotz´. 2nd Edition. Option Pricing Formulas. G. Haug. Risk.y1 = λ = 1 B2 √ ln σ τ SK µ2 + √ + (µ + 1)σ T 2r σ2 r−d 1 µ = − σ2 2 and N (•) is the cumulative normal distribution function (see [Ha07]). References [BG99] M. will suﬃce. The value of this option is given by Eq. Barrier Options Traded in the South African Markets. 3.G. 343-346 (1996) e [Ko99] A. 6. McGraw-Hill Companies (2007).

Unscrambling the Binary Code. Ya-Ching. Risk. University of Melbourne. (October 1991) [Sb00] Alessandro Sbuelz. Derivatives: the theory and practice of ﬁnancial engineering. G. 8 . Wiley (1998) [Ya03] Tung. no warranty is given as to its completeness and reliability. Department of Mathematics and Statistics. 2nd Edition. Reiner & M. 4. Hedging Double Barriers With Singles. and persons who rely on it do so at their own risk. A Thesis Submitted to the Graduate Institute of Finance in the Management School of the National Taiwan University in Partial Fulﬁlment of the Requirement for the Degree of Master of Science (June 2003) [Zh98] P. Zhang. Stoklosa. Working paper. Studies of Barrier Options and their Sensitivities.[RR91b] E. Pricing Parisian-Type Options. Rubinstein. Exotic Options: A Guide to Second Generation Options. FCT does not accept any responsibility for errors or omissions. Wilmott. World Scientiﬁc (1998) No part of this work may be reproduced in any form or by any means without Financial Chaos Theory’s written permission. Whilst all care is taken by Financial Chaos Theory’s (PTY) LTD to ensure that all information in this document is accurate. Honours Thesis (2007) [Wi98] P. Tilburg University (2001) [St07] J.

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