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I have a question regarding regular option pricing.

In the standard Black-Scholes model, with interest r and volatility $\sigma$, I have to eetermine the arbitrage free price at time $t$ of an option which at $T>t$ pays the holder the amount of 100 USD dollar if the stock price is between 50 and 100 USD.

I.e. an option with payoff function:

$$\phi(S) = 100 ~ \text{if} ~ 50<S_T<100 ~ \text{else} ~ 0$$

A thorough walk through in how to calculate this price would be highly appreciated.

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I am too lazy to write up a longer answer and I do not know how to write LateX, so here you go

Pricing formulas for Double Knock Out and Binary Range Options

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  • $\begingroup$ we should really create a B&S realted Q&A ... $\endgroup$ – Probilitator May 23 '14 at 9:49
  • $\begingroup$ is there one in existence? $\endgroup$ – Matt May 23 '14 at 9:52
  • $\begingroup$ there must be one somewhere. I think I will create a question asking people to contribute their favourite sources. This question and the answers can be than used as a referrer for the type of question you just answered :) $\endgroup$ – Probilitator May 23 '14 at 9:55
  • $\begingroup$ The link doesn't work anymore. $\endgroup$ – SmallChess Aug 21 '15 at 10:16
  • $\begingroup$ fixed........... $\endgroup$ – Matt Aug 21 '15 at 10:30
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The payoff can be decomposed as \begin{align*} \phi(S) &= 100 \, I_{50 \le S_T < 100}\\ &= 100 \, \big(I_{S_T \ge 50} - I_{S_T \geq 100}\big). \end{align*} Note that, under the risk-neutral measure $P$, \begin{align*} E(I_{S_T \ge K} \mid \mathcal{F}_t) &= P(S_T \ge K \mid \mathcal{F}_t)\\ &= N(d_2), \end{align*} where \begin{align*} d_2 = \frac{\ln \frac{S_t}{K} + \big(r-\frac{1}{2}\sigma^2\big) (T-t)}{\sigma\sqrt{T-t}}. \end{align*} The valuation of the above option payoff is now straightforward.

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