Passport Options: Continuous and Binomial Models
32 Pages Posted: 9 Dec 2010 Last revised: 17 Feb 2011
Date Written: December 8, 2010
In this paper we examine the problem of valuing an exotic derivative known as the passport option. This is a zero strike call on the value of a trading account, the performance of which is governed by the option holder's trading strategy. Whilst this problem has been analysed previously, our contribution proceeds in two directions. We not only provide a continuous time valuation which is constructed differently from the present literature, but also consider the valuation problem assuming the traded asset evolves according to a binomial lattice. Valuation of these contracts under such a framework has not previously appeared in the literature. We show that the optimal trading strategy for the passport option is the same in both the binomial and continuous time models. We also prove convergence of the binomial model to the continuous time case and provide some numerical examples.
Keywords: Passport Options, Binomial Models
JEL Classification: C61
Suggested Citation: Suggested Citation