What is the difference between valuation of deliverable and non-deliverable European options?

I am not asking settlement-wise, but daily valuation. Will Black-Scholes be used for both?


1 Answer 1


Without loss of generality, for a European call option with payoff $(S_T-K)^+$ at expiry $T$, whether the option is settled in cash or rather the strike/asset are exchanged should in theory have no impact on price. The net value of exchanging $S_T$ against $K$ if positive is equal to $S_T-K$, which is equal to the amount paid/received if the option is cash-settled.

Idiosyncratic market features might in practice result in some valuation differences between cash and physical delivery, which should probably be minor. For example, settlement lag between the option’s expiry and the date the trade is effectively settled might be different for cash and physical deliveries, which should translate in (tiny) valuation differences.

Note that there might products for which the cash-settled version has actually a different payoff that the physical delivery version. For example, a cash-settled swaption is not equivalent to a physically-settled one. In this case, physical delivery consists on delivery of the swap, whose value is implicitly based on discounting using the whole yield curve, whereas in cash delivery the discount rate used is assumed to be flat and equal to the prevailing swap rate.

For the purpose of computing counterpary adjustments such as CVA, cash and physical delivery also has an effect. With a cash settled option, your exposure to the counterparty vanishes at option expiry when the payoff is settled. On the other hand, for a physical settlement option on an OTC trade such as a non-cleared swap, you will remain exposed to the counterparty until the expiry of the underlying. Hence the CVA of a physically-settled option should be higher than that of the equivalent, cash-settled trade.

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    $\begingroup$ It is a good practice to account correctly for all the terms and conditions. For example, if an FX non-delivery option says to observe the FX rate on determination date 2 days before expiry, it would be more correct not to show delta to FX rate afterwards, than to show it until expiry, if the model ignores this feature. This may be a very material difference in output, but it's not a separate model of course. $\endgroup$ Commented Sep 9, 2021 at 14:02

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