Skip to content

Digital payoff outside the 15 to 20 band

Question

A contract pays 11 at expiry if the stock finishes at or below 1515 or at or above 2020, and 00 otherwise. Digital calls (paying 11 if ST≥KS_T\ge K) are quoted at: strike 1515 for 0.730.73, strike 17.517.5 for 0.340.34, strike 2020 for 0.130.13. The discount factor to expiry is 0.90.9. What is the contract worth today?

Short answer

0.300.30. The contract is a digital call at 2020 plus a digital put at 1515. A digital put and digital call at the same strike add up to a bond, so the put costs 0.9−0.73=0.170.9-0.73=0.17, and the total is 0.13+0.17=0.300.13+0.17=0.30 (ignoring the measure-zero point ST=15S_T=15).

Adapted from QuantQuestions.io; question and answer rewritten by SelfMadeQuant.com.

See the hint and the full worked solution in the question bank (free account).

Open the worked solution

Lessons behind this question

Start with a free lesson: Options is part of a free topic. Create a free account, no card needed, to read it in full with worked solutions.

Read it free