Digital payoff outside the 15 to 20 band
Question
A contract pays at expiry if the stock finishes at or below or at or above , and otherwise. Digital calls (paying if ) are quoted at: strike for , strike for , strike for . The discount factor to expiry is . What is the contract worth today?
Short answer
. The contract is a digital call at plus a digital put at . A digital put and digital call at the same strike add up to a bond, so the put costs , and the total is (ignoring the measure-zero point ).
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Open the worked solutionLessons behind this question
- Market Model and Risk-Neutral Valuation
- Option Mechanics: Calls, Puts, Moneyness, Intrinsic Value, and Exchange vs. OTC Markets
- Option Trading Strategies: Spreads, Combinations, and Payoff Engineering
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