OPTIONS 75

UNSCRAMBLINGTHE BINARYCODE
Binaryoptions,
unlikestandard
options,tendto havediscontinuous
pay-offs.
MarkRubinste
inandEricReiner
valuea varietyofthese
instruments

T he pay-offs of binary options tend to

be switched completely one way or
below (above) th e strike price (K), or pays
out a predetermined constant amount (X)
These options are simi lar to cash-or-
nothing options, except that when they
the other depending on whether the if the underlying asset finishes above (be- pay off th e amount is not predetermined
underlying asset price satisfies some low) the _strike price: but rather is equal to the underlying asset
condition. 1 This articl e considers a wide price at expiration. To value these, we
variety of binaries, first thos e with path- call: 0 if S':SK, or X if S'>K look instead to the first term of the Black-
independent pay-off s and then the more put: 0 if S 2:K, or X if S"<K
0
Scho les formula. This gives us exactly
complex barrier binaries with path- what we need : the unprotected present
dependent pay-offs. In a Black-Scholes environment, such an va lu e of the underlying asset price con-
Our objective is to value a variety of option is easy to value . Recall that the ditional upon exercising the option. So
these options in a Black-Scholes environ- Black-Scholes formula can be decomposed the value of an asset-or-nothing call is
ment, that is: into the difference between two terms: simply Sd- 1N(<j>x)
with <j>=l, and the value
the unprotected present value of the of an asset-or-nothing pu t is the same,
(1) where the underlying asset return can underlying asset price conditional upon but with <j>=-1.
be assumed to follow a lognormal random exercising the option, Sd- tN(<j>x)
, and the
walk, and Gap options Our next options are sligh tly
(2) wh e re arbitrage arguments allow us more complex than stan dard options:
to use a risk-neutral valuation approach
- discount the expected pay-off of the call: 0 if S':SK, or s·-X if S">K
option at expiration by the riskless interest Thepay-offof binaryoptions put: 0 if S'2:K, or S' -X if S'<K
rate, where the underl ying asset price is tendto beswitchedcompletely These options highlight th e dual role
expected to appreciate at the same riskless
rat e less pay-outs. onewayortheotherdepending played by th e strike price in a standard
op tion: K not only determines whether
Under these conditions, the (Black-
onwhether theunderlyingasset the option finishes in the money or out
Scho les) formula for a standard option is pricesatisfies
somecondition of the money but also the size of the
resulting pay-off (X). Th ere is no logical
- 1N(<j>x)-<j>Kr
C=<j>Sd - 1N(<j>x-<j>oVt) necessity for these tw o functions to be
where vested in a sing le number. The "gap" is
x=[log(Sd- 1/Kr- 1)-,-oVt]+½oVt present value of the strike price, Kr- 1, times defined as X-K. Positive gap calls will
th e risk-neutral probability of exercising clearly sell for less than standard calls,
S is th e present value of the underlying the option, N(<j>x-<j>oVt). If the predeter- while positive gap puts will be worth
asset, K is the strik e price , r is one plus mined pay-off of the cash-or-nothing call more than their sta ndard counterparts .
the rate of interest, d is one plus the pay- (X) were equal to the strike price (K), then The value of a gap option may be derived
out rate of the underlying asse t, t is the a cash-or-nothing call would be like a by subtractin g a cash-or-nothing option
time-to-expiration of the option, o is the stan dard written call except that, although from an asset-or-nothing option:
volatility of the underlying asset, N(·) is the writer receives the strike price, he is
the standard normal distribution function, under no obligation to deliver the under- - 1N(<j>
C=<j>Sd x)-<j>Xr-
1N(<j>x
-<j>oVt)
and the binary variable <j>is set equa l to lying asset. Such a "par tial call" would where
1 for a call and -1 for a put. 2 then be worth Kr- 1N(x-oVt) to the writer.
More ge nerally, allowi ng X'FK, the value
Path-independent
binary
options of a cas h-or-nothin g call would be xr- 1N This is almost identical to the Black-
(<j>x-<j>oVt)with <j>=l. Similarly, th e Scholes formula for a standard option.
Caslr-or-11otlri11g
calls a11dputs The simp- value of a cash-or-nothing put is th e same,
lest binar y call (put) pays off nothing if but with <j>=-1. Supershares In an article publish ed in
the und erlying asset price (S") finishes 1976, Nils Hakansson proposed a financial
Assct-or-11otlri11g
calls a11dputs' Somewha t intermediary that would hold an under-
1Fora brief taxonomyof some of thesecontracts(referredto more compl ex binary options, these have lying portfolio and issue claims called
there as digitaloptions).see Mike Hudson.Thevalueingoing the following pay-offs :
out, RISKMarch 1991, page31.
"s upershar es" against thi s portfolio to
call: 0 if S':SK, or s· if S">K investors .4 A supershare is a security that
' Sincethe valuesof standard Europeanoptionsdependonly on
the price of the underlyingassetat expiration.it 1spossibleto put: 0 if s ·2:K, ors· if S'<K
let r, d ando be knownfunctionsoftime.However,sincethe
options discussedin this article dependin complexwayson the 4 SeeNilsHakansson, Thepurchasingpower fund:a newkind of
pathstaken by the underlyingassetthroughtime. to keepmatters 3 Theseoptionsare discussedinJohnCoxand MarkRubinstein. financialintermediary,FinancialAnalystsJournal,November-
simple,we a~sumehere that these variablesare constant. OptionsMarkets.page460, Prentice-Hall,1985. December1976.

RISK VOL4/N0 9/OCTOBER1991

 OPTIONS 77

5 Coxand Rubinstein,OptionsMarkets,p.371-375 . describesa 6 Thenotationusedhereisconsistent withthatusedinour

rule for using a portfolio of standardcall options.and possibly Breakingdown the barriers,RISKSeptember 1991,pages28-35.
cashand the underlyingassetitself, to construct generalised
piecewiselinearpay-offpatterns.However , sincethese~basis"
securitiesall havecontinuouspay-otts,all portfoliosconstructed
from them must also havecontinuouspay-offpatterns.Using
cash-or-nothing andasset-or-nothing callspermitsdiscont inuous
pay-ottsas well (asillustratedIn the example). Fora givenset
of breakpoints,this approachalsopermitsgreater control over
the slopeof the pay-off pattern betweenbreakpoints than can
be providedwith supershares.

entitles its owner, on its ex piration date , pe s of diagonal line segments moving The expression h(t) is often called the
to a given dollar value proportion of the from left to right first passage time density.
assets of the underlying portfolio, pro- Let C(K) be the current value of a cash- Because we plan to define 28 typ es of
vided the value of those assets on that or-nothing call paying off $1 if and only path-dependent binary options with 44
date lies between a lower value K1and an if S'>K, and let A(K)be th e current value different formulas , it is convenient to pro-
upper value Kh. Otherwise, the s up ers har e of an asse t-or -nothin g call pa ying off s· vide some notation for th e desired pi eces:
expires worthless, Th a t is , the pay-off is: if a nd on ly if S'> K. The above pay-off
pattern can be re plicat e d by th e following [lA] =sr- 1/e"f(u)du=Sd - 'N(<jlx)
0 if S'<K 1 p or tfoli o: [lC] =xr- 1./f(u)du=Xr - 1N(<jlx
-<jloY t)
S'/K 1 if K1:oS<Kh [2A]= sr - '/e"f(u)du=Sd- 1N(<jixi)
0 if Kh:::S (Y1-A1X1)[C(xi)]-C(x2)]+ ),i(A(xi)- A(x2)] [2C]= xr- 1/f(u)du=Xr- 1N(<jlx1-<jloYt)
+(y4- A2X3)[C(x3)-C(x4)]
+ A2[A(x3)-A(x4)] [3A]= Sr- './e"g(u)du=Sd - 1(H/S)2;·N(TJY)
It is easy to see that such an option has + (y4- A3X4)[C(x4)-C(x
5)]+ A3(A(x4)-A(x 5)] [3C]= Xr- '.fg(u)du=
the same pa y -off as (l / K1) bullish vertical + (y3- A4X6)[C(x6)-C(x1)l
+ ),4[A(x6)-A(x 7)] Xr- 1(H/S)2;·- 2N(TJY-110Vt)
spreads of asset-or-nothing calls, where [4A]= Sr- 1.fe"g(u)du=Sd- 1(H/S)2;,N(11yi)
the purchased asset-or-nothing call ha s a Binary
barrieroptions [4C]= Xr- 1.fg(u)du=
strike price K1 and the written asset-or- Xr- 1(H/S)2)·- 2N(11Y
1 - TJoYt)
nothing call ha s a strike pric e Kh, That is, just as w e can value path-ind ependent [6] = Xf r- 'h(i:)di:=X[(H/S)a+bN(TJZ)+
binary options by selecting pi eces of th e (H/S)°-bN(T]Z - 211boVt)]
C=(Sd - 1/ K1)[N(x1)-N(x h)l Black -Sc hole s formula for standard op-
x1=[1og(Sd- 1/K1r- 1)-:-0Vt]+½0Vt, tion s, we can also construct so lutions for
where integrals [lA] and [lC] are taken over
xh=[log(Sd- 1/Khr- 1)-:-oVt]+ ½oVt binary barrier options from pieces of the
the region log(K/S) to qioo, the integrals [2A]
formulas for barrier options."
and [2C] arc tak e n over the region log(H/S)
These securities can be shown to be build- First, we will n ee d th e d e nsity of the
to qioo, the integrals [3A]and [3C] are taken
ing blocks for constructing other mor e natural logarithm , u, of the und e rlying
over the re g ion log(K/S) to T]oo,the integrals
common securities such as pur- risk-neutr a l asse t re turn
[4A] and [4C] are tak e n over the region
chased standard calls and puts,
log(H/S ) to T]00 , and integral (6] is taken
f(u)= (lloV2Jct)e- 'av'
over the region 0 to t, and
Portfolios of binary options Another wa y where v=(u-µt)/oYt, ft=log(r/d) - ½o 2
to construct arbitrary piecewis e linear
pay-off patterns is to mak e more direct Second, we n ee d the d e nsity , g(u), of the x = [log(S/ K)-:-oV t]+) ,oY t
use of cash-or-nothing and asset-or- natural logarithm of the underl y ing asset x1 = [log(S/ H)-:-oVt] +),oY t
nothing calls, 5 For example, consider the return, given that the asset pric e first starts y = [log(H2/SK)-:-oVt]+AoYt
pay-off pattern in figure 1, where )..1= (y2- at S above the barri e r H, crosses th e barrier y1 = [log(H/S)-:-oVt]HoVt
Y1)/ (x2-x i), A2=(y6-y4)/(xcx3), ),3= (YcY6)/ at least onc e, but ends up greater than H z = [log(H/S)-:-oVt]+bo V t
(x5-X4), and A4=(y3-y 5)/(x7-x 6) are the slo- at ex piration : ),_= 1+(µ/o 2)
a = µ/ o 2, b=[Y(µ 2+2(1og r)o2)]/o 2
g(u)=e21'n/o7( 1/ oY2rrt)e - l,:,v
2

1. Pay-offpattern where v=(u - 2T]U'-1iµt)/0Yt, U'=log(H/S) and the binary variables, T] and qi, each
Pay-off take values of either 1 or - 1.
y6 This js a normal density pr e multipli ed b y We now catalogue our valuation res ults.
Y5 e2" 0 1". Herc Tj=l. Alternatively, given Options 1-4 all have pa y-o ffs th a t arc re-
that th e underlyin g asset pric e first s ta rts ceived th e moment the barrier is
below the barrier, the density of th e logar- breached:
ithmic return wh e n th e und e rlying asset
price breaches the barrier but ends up (1) down-and-in cash·(at hit)-or-nothing(S>H)
below the ba rrier at expiration is the same pay-off: X (at hit) if for some ,:S t, S(1)S H
ex pres sion but with T]=- 1. 0 if for all ,:S t, S(i:)>H
Finally, we need an additional density value: [6] {T]=l}
for the first tim e t that the und e rlying
asset price crosses th e barrier: (2) up-and-in cash-(at hit)-or-nothing(S< H)
Oc_--' _ _j_ _ _J_ _ .....L _ _,.__--'--_.,___ S. pay-off: X (at hit) if for some ,:SI, S(1)::,.H
h(t)=(- T]U'
lo tV2in)e - 'av' 0 if for all i:S t, S(i:)<H
0
where v=(-TJU'+T]µt)/oYt value: [6] {ri=-1}

RISK VOL4/N09/0CTOBER 1991

1s OPTIONS

2. Familytreeof binaryoptions

Path-indipendent Path-<lependent

r
(Payout expiry)
Payoutat hit
(1-4)
Payoutat expiry
(5-28)

(Strikeonly)
I
(Barril only)
Barrieronly Barrierand strike
(5-12) (13-28)

Un}
In Qut In Out
15-8} (9-12} (13-20} 121-28}
I I I I
I
Down Up 0o""1
I Up
I
Down
I Up
I I
Down Up Down Up

n n n n n n nnnn
0 ,3} 12,4} 15,6} 17,8} 19,10} (11,12} 03,15,17,19} (14,16,18,20} (21,23,25,27) 122,24,26,28}

Cash Asset Cash Asset Cash Asset Cash Asset Cash Asset Cash Asset Cash Asset Cash Asset Cash Asset Cash Asset Cash Asset

nn
orO orO at hit at hrt atM athit orO orO or O or 0 or O or 0 or O orO

nnnnnnnn orO orO orO orO orO orO orO orO

r~
Call Put Call Put Call Put Call Put Call Put Call Put Call Put Can Put Call Put Call Put
(I} 12} 13} (4} 15} (6} 18} 19} (10} (II} (12} (13} (17} (15} (19} (14} 118}116}120}121}125}(23} 127}122}126}124}128}

Gap Gap Supershare

PORTFOLIOS --·-M ·M -·M ·-M
Down- Down- Up- Up- Down- Down- Up- Up-
call put and-in and-in and-in and-in and-out and-Out and-Out and-OU!
I I call put can put caU put call put
Std Std
call put

The pay-off from an "in" cash-(at hit)-or- world of Black-Scholes, the value of the (7) down-and-in asset-(at expiry)-or-nothing (S>H)
nothing option is identical to the rebate underlying asset (S(t)) at the moment the pay-off: S(t) (at expiry) if for some ,st,
portion of a down-and-out or up-and-out barrier is hit must be equal to the barrier S{t)SH
option where the rebate equals X. itself (H). 0 if for all ,:St, S(i:)>H
All the remaining options have pay-offs value: [2A] + [4A] {TJ=l, <jJ=-1}
(3) down-and-in asset-(at hit)-or-nothing (S>H) received only at expiration . Options 5--8
pay-off: S{t) (at hit) if for some ,st, have positive pay-offs requiring only that
S(t)SH the barrier (H) be breached at some time (8) up-and-in asset-(at expiry)-or-nothing(S<H)
0 if for all ,:St, S(,:)>H before expiration: pay-off: S(t) (at expiry) if for some ,:St,
value: [6] {TJ=l, X=H} S(t)~H
0 if for all ,:St, S(t)<H
(5) down-and-in cash-(at expiry)-or-nothing (S>H)
(4) up-and-in asset-(at hit)-or-nothing (S<H) value: [2A] + [4A] {TJ=-1, <jJ=l}
pay-off: X (at expiry) if for some ,st,
pay-off: S(t) (at hit) if for some ,st,
S(t)SH
S{t)~H
0 if for all ,:St, S(t)>H
0 if for all ,:St, S(,:)<H The pay-off from an "in" asset-(at expiry)-
value: [2C] + [4C] {TJ=l, <jJ=-1}
value: [6] {TJ=-1, X=H} or-nothing is identical to the pay-off from
a down-and-in or up-and-in call for which
The valuation of "in" asset-(at hit)-or- (6) up-and-in cash-(at expiry)-or-nothing (S<H) both the strike price and rebate are zero.
nothing options may at first seem to be pay-off: X (at expiry) if for some ,st, Options 9-12 have positive pay-offs re-
difficult because the buyer appears to re- S(t)~H quiring only that the barrier (H) not be
ceive a random amount at a random time . 0 if for all ,st, S(i:)<H breached before expiration; they are the
However, in the continuous price path value: [2C] + [4C] {TJ=-1, qi= 1} "out" complements to options 5--8.

RISK VOL 4/N0 9/OCTOBER 1991

OPTIONS 81

(9) down-and-out cash-or-nothing (S> H) (13) down-and-in cash -or-nothing call (S>H) (17) down-and-in cash-or-nothing put (S> H)
pay-off: X (at expiry) if for all , s t, S(1)> H pay-off: X (at expiry) if S(t)> K and for pay-off: X (at expiry) if S(t)< K and for
0 if for some 1st, S(1)SH some 1st, S(1)SH some 1st, S(1)sH
value: [2C] - [4C] {l]=l, cj>=l} 0 if S(t)< K or for all 1st, 0 if S(t)<K or for all 1st,
S(1)>H S(1)>H
value (K> H):[3C] {1'l= 1) value (K> H)[2C] - [3C] + [4C] {l]=-1 ,
(10) up-and-out cash-or-nothing (S<H) value (K<H) [lC] - [2C] + (4C] {ri=l, cj>
=- 1)
pay-off: X (at expiry) if for all , s t, S(1)< H cj>=l} value (K<H): [lC] {cj>= - 1)
0 if for some 1st, S(1)2 H
value: [2C] - [4C] {l]= - 1, cj>=-1}
(14) up-and-in cash-or-nothing call (S< H) (18) up-and-in cash-or-nothing put (S<H)
pay-off: X (at expiry) if S(t)> K and for pay-off: X (at expiry) if S(t)< K and for
(11) down-and-out asset-or-nothing (S>H) some 1st, S(1)2H some 1st, S(1)2 H
pay-off: S(t) (at expiry) if for all 1st, S(1)>H 0 if S(t)< K or for all 1st, 0 if S(t)<K or for all , s t,
0 if for some 1s t, S(1)SH S(1)< H S(1)<H
value: [2A] - [4A] {l]=l, cj>=l} value (K> H): [lC] {cj>
= l) value (K> H):[lC] - [2C] + [4C] {ri=- 1,
value (K< H):[2C] - [3C] + [4C] {ri=- 1, cj>
=- 1)
cj>
= l} value (K< H):[3C] {l]=- 1}
(12) up-and-out asset-or-nothing (S< H)
pay-off: S(t) (at expiry) if for all 1s t, S(,)< H
0 if for some 1st, S(1)2H
Suppose X were equal to the strike pric e Suppos e X were e qual to the strike pric e
value: [2A] - [4A] {l]=-1, cj>=-1}
of a down-and-in or up-and in call. Then of a down-and-in or up-and-in put. Then
the strike price portion of the pay -o ff of the strike pric e portion of th e pay-off of
The pay -off of a down -a nd -o ut cash-or- th ese ca lls ha s the same value as an other - thes e puts h as th e same value as an other-
nothing option is equal to - X/H times the wi se id e ntical "in" cash-or-nothing ca ll. wis e identical "in" cas h -or-nothing put.
cash portion of th e p ay -off of a down -
and-ou t call with strike price H, and the
(15) down-and-in asset-or-nothing call (S> H) (19) down-and-in asset-or-nothing put (S> H)
pay-off of an up-and-out cash -o r-nothing
pay-off: S(t) (at expiry) if S(t)> K and for pay-off: S(t) (at expiry) if S(t)< K and for
is equal to X/ H times the cash portion of
some 1s t, S(1)SH some 1st, S(1)S H
an up -and-out put with strike price H.
0 if S(t)<K or for all 1s t, 0 if S(t)< K or for all 1s t,
Similarly, the pay -o ff from an "o ut " asset-
S(i:)> H S(1)> H
or -nothing is identi ca l to the pay -off from
value (K> H): [3A] {l]= 1} value (K> H):[2A] - [3A] + (4A] [ri= l ,
a down-and-out or up -and -out ca ll with
value (K< H): [lA] - [2A] -l- [4A] {ri= l , cj>=- 1}
both th e strike price a nd rebate equal to
cj>
= l) value (K< H): [lA] {cj>=- 1}
zero.
These results may be obtained from
formulas 5-8 by noting that a portfolio (20) up-and-in asset -or-nothing put (S< H)
(16) up-and-in asset-or-nothing call (S< H)
consisting of an "out" option and its com- pay-off: S(t) (at expiry) if S(t)< K and for
pay-off: S(t) (at expiry) if S(t)> K and for
plementary " in" will always pay off at some 1s t, S(1)2 H
some 1s t, S(1)2 H
expiry, re gar dle ss of whether or not the 0 if S(t)< K or for all 1s t,
0 if S(t)< K or for all 1s t,
barrier is crossed. Co n seq u e ntly, we ca n
S(1)< H S(1)< H
derive parity rela tion s eq u a tin g th e sum
value (K> H): [lA] {cj> = 1) value (K> H)[lA] - [2A] + [3A] (l] =- 1,
of the present values of th e two o ption s
value (K< H): [2A] - [3A] + [4A] {l]=-1, cj>=-1}
to the present valu e of deliv e ry at expira-
cj>
= l} value (K< H):[3A] {l]= - 1)
tion of cash or the und e rlyin g asset. For
example, th e value of a down -a nd -o ut
cash -or-nothing (9) is merely th e differ - An "in" asset-or-nothing call has th e same An " in " asset -or -nothin g put ha s th e
e nce be tw ee n th e present va lu e of X deli - value as the asset portion of the pay -off sa m e value as th e asset portion of th e pay -
vered un co ndition a lly a t exp iry (Xr- 1) and of an otherwise id e nti ca l down -and -in or off of an otherwise id e nti ca l down -a nd -
o ur re s ult for op tion 5. up -and -in ca ll . in or u p -an d -in ca ll .
Options 13- 16 have positive pay -offs Options 17- 20 h ave positive pay -offs Options 17- 20 hav e positive p ay -off s
requiring not only that th e barrier (H) be requiring not only that the barrier (H) be requirin g not only that the barri er (H) be
breach ed, but also that the underlying breached but also that the und e rlying breach ed but also that the under lying
asset finish above a g iven leve l (K). as se t finish below a given leve l (K). asset fini s h below a given lev e l (K).

RISK VOL4/NO 9/ 0CTOBER1991

OPTIONS 83

(21) down-and-out cash-or-nothing call (S> H) be breached but also that th e underlying the list 13-20 and its "out" complement
pay-off: X (at expiry)if S(t)> K and for asset finish below a given lev e l (K). from 21- 28 is equivalent to one of th e
all r s t, S(i:)>H path-independent binaries we discussed
0 if S(t)<K or for some ,::St, (25) down-and-out cash-or-nothing put (S>H) earlier. Alternatively, an "in " call from 13-
S(i:):SH pay-off: X (at expiry)if S(t)<K and for all 16 togeth er with the corresponding put
value (K> H):[lC] - [3C] {ri=l, cp=l} t :St, S{t)> H from 17-20 comprise a position identical
value (K< H) [2C] - [4C] {ri= l, cp=l} 0 if S(t)< K or for some t :St, to one of the barri er-onl y " in" options
S(t):SH from 5--8. Similar res ult s link position s
(22) up-and-out cash-or-nothing call (S< H) value (K> H): [IC] - [2C] + [3C] - [4C] constructed from the "o ut " calls and put s
pay-off: X (at expiry) if S(t)> K and for {ri= l, cp=- 1} 21- 24 an d 25--28 with barrier-only "ou t"
all , :St, S(i:)<H value (K< H): 0 options from 9-12.
0 if S(t)<K or for some t:St, We ma y also combine options 13-28 in
S(t)2:H (26) up-and-out cash-or-nothingput (S< H) ways that yield more familiar securities .
value (K> H): 0 pay-off: X (at expiry)if S(t)< Kand for all Each of the barrier options examined in
value (K< H) [IC] - [2C] + [3C] - [4C] t :St, S(t)< H o ur previou s article ma y be built from
{ri=- 1, cp= l} 0HSW < Korforwmei: :St, an asset-or-nothing option from this list
S(t)2:H a nd a corres pondin g cas h -or- nothin g with
Suppose X were equal to th e strike price value (K> H):[2C] - [4C] {ri=- 1, cp=- 1} X se t equal to K. For exa mpl e, a do wn -
of a down-and-out or up-and-out call. value (K< H):[lC] - [3C] {ri=-1 , cp=-1} and-in call ma y be synthesised from a
Then the strike price portion of th e pay- long asset-or-nothing down-and-in call
off of th ese calls has the same value as an Suppose X were equal to th e strike price and a s h o rt cash-or-nothing down-and -
otherwise identical "out" cash-or-nothing of a down-and-out or up-and- o ut put. in call with th e same strike price and with
call. It m ay seem surprising that a n up - Then the stri ke price portion of the pay - X=K.
a nd -out cas h -or-nothing call sh o uld be off of thes e puts ha s th e same value as Finall y , we can construct barri er -
worth n o thin g wh en th e st rik e price is an oth e rwise id entica l "out " cas h -or - d e pendent a nd strike -dep e nd ent gap op -
g rea te r than th e barrier. But it is easy to nothin g put. tions and sup ers h a res ana logo us to th ose
see why . Since S< H< K, in order for the presented in the first part of this articl e
und e rlyin g asset to e nd up above K, it (27) down-and-out asset-or-nothing put (S> H) for path-dependent conditions. H oweve r,
must first breach the barri er H, but in this pay-off: S(t) (at expiry) if S(t)< K and for perhaps .. -•
eve nt , th e ca ll is exting ui s hed . all t :St, S(t)> H
0 if S(t)< K or for some t :St,
(23) down-and-out asset-or-nothing call (S> H) S(i:):SH
pay-off: S(t) (at expiry) if S(t)> K and for value (K> H): [IA] - [2A] + [3A] - [4A]
all t :St, S{t )> H {ri= l, <1> =- l}
0 if S(t)< K or for some t :St, value (K< H): 0
S{t):SH
value (K> H):[lA] - [3A] {ri=l, cj> = l} (28) up-and-out asset -or-nothing put (S< H)
value (K< H):[2A]- [4A] {ri= I , cp= l} pay-off: S(t) (at expiry) if S(t)< K and for
all t :St, S(t)< H
(24) up-and-out asset-or-nothing call (S< H) 0 if S(t)< K or for some i::St,
pay-off: S(t) (at expiry) if S(t)> K and for S(t)2:H
all 1:St, S(t)< H value (K> H): [2A] - [4A] {ri=- 1, cp=- 1}
0 if S(t)< K or for some t :St, value (K< H):[lA] - [3A] {ri=- 1, cp=- 1)
S(1)2:H
value (K> H):0 An "out " asset-o r-nothin g put has th e
value (K< H): [IA] - [2A] + [3A] - [4A] same value as the asset portion of th e pay-
{ri=- 1, cp= l} off of an othe rwi se identical down-and-
o ut or up -an d -o ut ca ll.
An "ou t" asse t-or -nothin g call h as th e Ju st as th e re are "parity" relations b e-
sa me valu e as th e asse t portion of th e pay - tw ee n our res ult s 5--8 a nd 9- 12, so, too ,
off of an o th e rwi se id e ntical down -a nd - can we find equ aliti es that link sum s of Mark Rubinstein is a professorof finance at t he University
out or up-and-out call. th e values of option s 12- 28 with th e values of California, Berkeley, and he and Eric Reiner are,
Options 25--28 have positive p ay -offs of less complex securities . For exa mple , a respectively, a principal and vice-president of Leland
requirin g not on ly th a t th e barrier (H) 110/ portfolio con sistin g of an "in " option from O'Brien Rubinstein Associates

RISK VOL 4/ N0 9/ OCT0BER1991

 CORRECTION
A production error led to the repetition of a
paragraphin Mark Rubinsteinand Eric
Reiner'sarticle Unscrambling the binary
code in the October 1991 issue of RISK.
The final paragraph of the third column of
page 81 should read:

Options 21-24 have positive pay-

offs requiring not only that the barrier
(H) not be breached but also that the
underlying asset finish abovea given
level (K).

VOL5/NO I/DECEMBER1991-JANUARY
1992