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typo: should be 45 instead of 4
mbison
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In the book of De Weert he approximates the price with a strip of knock-outs. For example the lookback call with fixed strike pays the (max(S) - K)+, is approximated by a strip of knockout calls with a rebate. So whenever the stock sets a new high, another call knocks out and you receive your rebate. In his example the rebates are 1 cent apart. So if the stock moves from $\\\$45$ to $\\\$50$, you will have collected $\\\$5$ in rebates.

Anyways:

  • do you agree that a knock-out call while it is a live is long gamma?
  • do you agree that a barrier option that is knocked out has no gamma?
  • do you agree that a barrier option has more gamma when spot is closer to the strike?

Assuming you agree with the 3 bullets above. you can see that once the stock goes up and knocks out a few barrier options. and then spot drops, the strip of barriers will have less gamma.

mbison
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