Best/Worst of Option Valuation
FinPricing provides valuation models for:
- Best of Option
- Best of Option with Caps and Floors
- Worst of Option
- Worst of Basket Return
- Option on Maximum
- Option on Minimum
- Minimum Absolute Deviation
- Minimum Absolute Return
- Check FinPricing valuation models
1.Best of or Worst of Option
A best of option is an option whose payoff is based on the best return from a basket of assets, while a worst of optionis an option on the worst return of a basket of assets.
If there are n underlying assets, the payoff effectively has n possibilities. Best of option pays the maximum price of all the assets whereas worst of option pays the minimum price within the basket.
An investor, for instance, can choose three assets reflecting growth, moderate, and conservative investment styles. In a upside market, the growth asset gives the best return. In a downside market, the conservative asset will have the best performance.Using the best of option, the investor will always get the best return.
2.Parity between Best of and Worst of
There is a relationship between best of option and worst of option given by:
where x, y are either a put option or a call option.
3.Payoff and Valuation
There are several types of payoffs as below:
The valuation model assumes that asset values can be accurately expressed using a volatility skew model. This assumption is thebest market practice for modelling equity prices. The pairwise correlation between assets are constant. This is also a commonassumption in industry. Furthermore, future dividend dates, amounts, and yields are known and fixed.
4.Related Topics
