# "Cash or nothing" and "Asset or Nothing" binary on shares

Discussion in 'P1.T3. Financial Markets & Products (30%)' started by Oracleyoda, Apr 25, 2010.

1. ### OracleyodaNew Member

I am trying to use the relevant formula from Black Scholes to value both of these digitals on a common stock

Say;

Option type = Put

Strike = 50
S = 50
CC Dividend Yield = 0.75

2. ### OracleyodaNew Member

And Standard Deviation for the Stock is 20%

3. ### David Harper CFA FRMDavid Harper CFA FRM (test)Staff Member

Wayne,

This is belated, but i was developing a binary XLS for our library, so maybe you'd find helpful. Here is a copy of rough with your numbers input, please see rows 28 to 31:

http://sheet.zoho.com/public/btzoho/0517-binary

My references (including Culp) and my intuition, like yours, suggest that dividend should be treated the same way. And the theory, too: specifically, the cash or nothing is a special case of BSM.

And the test, it seems, is to compute the cash-or-nothing call and the cash-or-nothing put. The combination of the positions--note the elegance of this(!)--must be $1; i.e., at strike =$1, the payoff is a certain $1. And so, using your numbers: cash-or-nothing call =$0.5101 (note this is a d2 that is influenced by d1; by my d1 = 0.1945 per the -div. Please note that subtracting the dividend outright is equivalent to the alternative of embedding it inside the LN(). That is: LN(S*EXP[-q*T]/K) = LN(S) + LN(EXP[-q*T]) - LN(K) = LN(S/K) + (-qT) = LN(S/K) - qT ... so just a reminder the "adjustment" can be found in one of two places and your texts may not explicitly refer to that....or perhaps they merely assume a non-dividend paying stock

In this case, I get:
cash-or-nothing call = $0.5101 cash or nothing put =$0.46878
and sum of cash or nothing put and call = $0.97897 (cell C31) which should equals the discounted value of a certain$1 to be received in 0.5 years(!) = EXP(-4.25%*0.5), which it does.
... so this would appear to validate your intuition that the treatment of dividends is the same

David

4. ### OracleyodaNew Member

David,

One of the things that sent me in the wrong direction was a model published by one of the very prominent US business schools.

I could not get their answer without making some unnatural assumptions. I eventually contacted them and it turns out their model was wrong and has since been corrected.

The lesson there I guess is not to place blind trust everything that is in the public domain.

Many thanks
Wayne

5. ### David Harper CFA FRMDavid Harper CFA FRM (test)Staff Member

I think they probably deploy initially a non-dividend model (it's always the first learning step) then maybe they forget to adjust when dividends are layered in - David