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Pricing Onion Options: A Probabilistic Approach

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  • Thorsten Upmann

Abstract

As argued by Ebenfeld, Mayr and Topper (2002), Onion options may be decomposed into one-touch double barrier binary options (ODBs). Using this idea, these authors provide an arbitrage-free pricing formula for Onion options within the Black-Scholes framework. Their approach rests upon solving the underlying partial differential equation. In this paper, we take an alternative and more direct route: Based on a probabilistic approach, we compute the risk-neutral valuation formula for an ODB. Then, by inverting the decomposition of an Onion option, we are able to derive an alternative pricing formula for this type of an option.

Suggested Citation

  • Thorsten Upmann, 2013. "Pricing Onion Options: A Probabilistic Approach," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 4(4), pages 11-25, October.
    • Handle: RePEc:jfr:ijfr11:v:4:y:2013:i:4:p:11-25
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    References listed on IDEAS

    as
    1. Peter Buchen & Otto Konstandatos, 2009. "A New Approach to Pricing Double-Barrier Options with Arbitrary Payoffs and Exponential Boundaries," Applied Mathematical Finance, Taylor & Francis Journals, vol. 16(6), pages 497-515.
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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