digital option pricing
Posted: February 14th, 2006, 10:43 am
by Doubtfin
cheers
digital option pricing
Posted: February 14th, 2006, 12:54 pm
by gjk77
P. Hagan has a paper on this somewhere in the forums. Let V(K) be the value of a call option at strike K. Then the digital option is replicated as close as one likes by (1/eps)[V(K-0.5*eps)-V(K+0.5*eps)] where eps is small, a few basis points. The smaller eps, the closer the call spread is to a digital.