Gap Options


What are Gap Options?

The gap option is an example of Exotic options in which we purchase a European option with two strike prices, X1 and X2. X2 is also referred to as trigger price as it's the price that makes the profitable if X2 is greater than X1, and the stock price at maturity,  ST, is greater than the trigger price, X2, then the payoff for the call option will be equal to ST − X1. If the stock price is less than or equal to X2, the payoff will be zero.

Why are Gap Options important?

Gap options allow the investor to make a unique hedge that is also affordable. As there is a gap between the strike prices, the payoff is less likely to be in positive territory and hence, prices of gap options are cheaper.

 

Topics: ACCA, CIMA, CPD, AAT, FRM