Jun 25

Exchange option – 6 min. screencast

by David Harper, CFA, FRM, CIPM

FRM |

margrabe_thumb

An exchange option is a general case of a plain-vanilla option: instead of a fixed strike price (K), the underlying asset (denoted by ‘V' here) is purchased with another asset (denoted by ‘U'). There are almost infinite varieties:

  • Exchange one currency for another
  • Warren Buffet has argued for indexed executive stock options (ESOs). These can be prices as exchange options: exchange S&P 500 Index for company shares.

The pricing is elegant. The Margrabe is a modified Black-Scholes with three substitutions (notice the riskless rate drops out entirely!):

margrabe_exchange_options

Screencast:

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