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Continuing on the example above, suppose now that the initial price of Alice's house is $100,000 and that Bob enters into a forward contract to buy the house one year from today. But since Alice knows that she can immediately sell for $100,000 and place the proceeds in the bank, she wants to be compensated for the delayed sale.
For example, for bond options [3] the underlying is a bond, but the source of uncertainty is the annualized interest rate (i.e. the short rate). Here, for each randomly generated yield curve we observe a different resultant bond price on the option's exercise date; this bond price is then the input for the determination of the option's payoff.
For example, a futures contract on a zero-coupon bond will have a futures price lower than the forward price. This is called the futures "convexity correction". Thus, assuming constant rates, for a simple, non-dividend paying asset, the value of the futures/forward price, F(t,T) , will be found by compounding the present value S(t) at time t to ...
The payoff of the call option on the futures contract is (, ()). We can consider this an exchange (Margrabe) option by considering the first asset to be e − r ( T − t ) F ( t ) {\displaystyle e^{-r(T-t)}F(t)} and the second asset to be K {\displaystyle K} riskless bonds paying off $1 at time T {\displaystyle T} .
Considering the next payment only, both parties might as well have entered a fixed-for-floating forward contract. For the payment after that another forward contract whose terms are the same, i.e. same notional amount and fixed-for-floating, and so on. The swap contract therefore, can be seen as a series of forward contracts.
A cliquet option or ratchet option is an exotic option consisting of a series of consecutive forward start options. [1] The first is active immediately. The second becomes active when the first expires, etc. Each option is struck at-the-money when it becomes active. [2]
The condor is so named because of its payoff diagram's perceived resemblance to a large bird such as a condor. [ 6 ] An iron condor is a strategy which replicates the payoff of a short condor, but with a different combination of options.
The payoff at maturity depends not just on the value of the underlying instrument at maturity, but also on its value at several times during the contract's life (for example an Asian option depending on some average, a lookback option depending on the maximum or minimum, a barrier option which ceases to exist if a certain level is reached or ...