With only minor adjustments to the contract details, the trading risks on European vanilla options can be significantly changed. The adjustments discussed in this chapter are late-delivery, American exercise, and self-quanto payoff.
Late-Delivery Vanilla Options
Consider the options shown in Exhibit 27.1. Leg 1 is a standard European vanilla option with a 1yr expiry. Leg 2 is identical except that the delivery date is one year after the standard delivery date. For a European vanilla option with the standard delivery date, the price of a physically delivered option is the same as the price of a cash-settled option. However, for a late-delivery vanilla option the price difference can get large.
In practice, Exhibit 27.1 doesn't contain enough information to price the late-delivery option because these same contract details could represent three different derivative contracts. When pricing late-delivery options it is important to confirm exactly what payoff is required and understand what methodology the pricing model uses so any necessary additional adjustments can be made.
Late Cash Vanilla Options
The late-delivery vanilla option in Exhibit 27.1 could be a late cash vanilla option. At maturity, the option is exercised against a fix. The option is then cash ...