Ericeric

October 24th 2007, 11:12 PM

"Derivatives markets" said the gap option is not an "option". You must exercise it even you will lost money, and the price of gap call can be negative.

However, in the example of ACTEX, PR6-5.

It said that value of call is zero if money lost when exercise it.

Is it the question and solution has problem??

sammuelcheng

November 1st 2007, 03:29 PM

I am thinking of the following,

The payoff function of a gap call should be

(S - K_1) * I{S >= K_2}, where S is the spot price, K_1 is the strike price, K_2 is the trigger, I{.} is the indicator function.

Similarly, the payoff function of a gap put should be

(K_1 - S) * I{K_2 >= S}.

Comparing with that of a vanilla call and a vanilla put, which are

(S - K) * I{S >= K}

and

(K - S) * I{K >= S},

the gap will follow the Black-Scholes dynamics, hence the gap are options.

jakebala

November 15th 2007, 08:04 PM

A gap option is called an option but when it comes to it, u don't have a choice to exercies.

take for example a call that has strike 40 and barrier 35. if the stock price at maturity is 37 then the barrier says you must exercise, but you lose 3 bucks.

now take for example a call that has strike 40 and barrier 45. if the stock price at maturity is 43 then you can't exercise even though you would have made 3 bucks.

overall, gap options are less expensive than regular options. a gap that has strike = barrier is a regular option

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