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A note on the valuation of compound options

✍ Scribed by Fatma Lajeri-Chaherli

Publisher
John Wiley and Sons
Year
2002
Tongue
English
Weight
107 KB
Volume
22
Category
Article
ISSN
0270-7314

No coin nor oath required. For personal study only.

✦ Synopsis

Abstract

The value of a compound option, an option on an option, has been derived by Geske
(1976) using Fourier integrals. This article presents two alternative proofs to derive the value of a
compound option. One proof is based on the martingale approach, which provides a simple and powerful tool for
valuing contingent claims. The second proof uses the expectation of a truncated bivariate normal variable. These
proofs allow for an intuitive interpretation of the three elements constituting the value of a compound option.
Β© 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:1103–1115, 2002

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