Contingent Premium Options
Posted: 15 Mar 2001
This article describes the valuation, hedging and applications of contingent premium options (CPOs). We derive closed-form formulas for path independent and path dependent CPOs that address most cases of practical importance. The resulting hedge ratios show that when it is not possible to hedge these options statically, hedging CPOs may become problematic, especially when the options approach maturity. We also discuss how to structure more specific CPOs, such as money-back and pay-later options. For an investor with a strong view on the price of the underlying asset, these types of options may be an attractive alternative to standard options.
Keywords: Derivatives, Exotic Options
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