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12 votes

How to derive the price of a square-or-nothing call option?

I provided an answer, based on an elementary approach, to an exactly same question yesterday. However, that question has disappeared, even though I like to keep a record for what I wrote. I would …
Gordon's user avatar
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5 votes
Accepted

Greeks for binary option?

For a digital option with payoff $1_{S_T > K}$, note that, for $\varepsilon > 0$ sufficiently small, \begin{align} 1_{S_T > K} &\approx \frac{(S_T-(K-\varepsilon))^+ - (S_T-K)^+}{-\varepsilon}.\tag{1} …
Gordon's user avatar
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3 votes
Accepted

Hedging a binary option close to expiry

The key point here is that when close to maturity a binary option should be hedged with a call spread. … Note that, for a binary option with a payoff at maturity $T$ of the form $\mathbb{1}_{S_T>K}$, the value at time $0\le t < T$ is given by $$e^{-r(T-t)}N(d_2), $$ where $$d_2 = \frac{\ln \frac{S_t}{K}+( …
Gordon's user avatar
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