Start your free trial Chapter 21European Digital Options European digital options are conceptually one of the simplest exotic products; at maturity the option either pays out a fixed cash amount or nothing, depending on whether spot is above or below a specified digital level. However, the risk management of these options, particularly at expiry, can be challenging due to the binary nature of the payout either receive all the cash or none over a one-pip spot difference.
A European digital call option pays out cash on the delivery date if spot at maturity is at or above the digital level, as shown in Exhibit While a European digital put option pays out cash on the delivery date if spot at maturity is below the digital level.
Exhibit Put another way, transacting both the digital put and digital call with all other details the same should not result in both contracts paying out.
In practice these issues digital option dealt with via the confirmation documents agreed when trading the contract. European digital options prices are quoted as a percent of the payout amount, with prices