Given r=0, σ(K)=const Binary=lim┬(ε→0)〖((C(K,σ(K))-C(K+ε,σ(K+ε))))/ε〗 What is the analytical expression for the binary option value?
σ(K)=const Therefore, Binary=lim┬(ε→0)〖((C(K)-C(K+ε)))/ε〗
What is the next step? Thank you
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$\begingroup$ This isn't how I would compute the value of a binary option, but your next step would appear to be taking the limit itself as epsilon goes to 0, no? You are effectively looking at the derivative of C(K) by the definition of derivative. $\endgroup$– user59Nov 8, 2014 at 16:14
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$\begingroup$ please write your answer in LaTeX (or it will be closed). $\endgroup$– emcorNov 8, 2014 at 16:35
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$\begingroup$ so the answer is dC/dk? $\endgroup$– RiserNov 8, 2014 at 18:35
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$\begingroup$ Is this the correct answer? dC/dK= e^(-rT)*N(d_2 )= N(d_2 ) as r=0 $\endgroup$– RiserNov 8, 2014 at 19:32
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if you let the implied vol depend on K you get two terms the first is
$N(d_2) $
but you get a correction term which is the slope times the vega
$$ \frac{\partial C}{\partial \sigma} \frac{\partial \sigma}{\partial K}.$$
(see eg my book)
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$\begingroup$ Mark Thanks for your input. Are you referring to The concepts and practice of Mathematical Finance. Which page? $\endgroup$– RiserNov 8, 2014 at 23:24
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$\begingroup$ i can't remember the page but it's chapter 7 $\endgroup$ Nov 9, 2014 at 6:19
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$\begingroup$ Mark, Thank you. I had one more, how can you show that th e price of a binary is not monotonous with volatility for OTM call. $\endgroup$– RiserNov 9, 2014 at 14:59