Digital Option

All or nothing, decided at one level

A digital — or binary — option pays a fixed amount if the underlying finishes on the right side of a level, and nothing if it does not. There is no proportional payoff: finishing a pip beyond the strike pays the same as finishing a figure beyond it. That makes the price a clean statement of probability, and it makes the option almost impossible to hedge in the last hours of its life, because the payoff jumps rather than slopes.

Open in the app · Exotics · intermediate

Exotics is part of the OTC Learn subscription. Everything the app shipped with — 36 products across six asset classes — stays free.

What the lesson covers

1. What it is
2. How it works
3. Why it’s used
4. European and American
5. Risks to watch

Key terms

• Cash-or-nothing — A digital paying a fixed cash amount if the condition is met, and nothing if it is not.
• Payout — The fixed sum a digital pays on exercise; the price is quoted as a percentage of it.
• Call spread replication — Hedging a digital with a long and a short vanilla struck either side of the trigger.
• One-touch — An American digital paying if the level is reached at any time before expiry, not only at it.
• No-touch — The mirror contract, paying only if the level is never reached during the option’s life.
• Pin risk — The unhedgeable exposure left when the underlying sits on the strike as the option expires.

In practice

FX options desks quote digitals continuously and use them as the building block for touch structures and accrual notes. Buyers are typically hedgers with a threshold exposure — a payment triggered by a rate breaching a level — and macro funds expressing a dated view on an event rather than on the size of a move.

Read next

• FX Option — The right to exchange currency at a strike
• Barrier Option — A vanilla that switches on or off at a level
• Range Accrual Note — A coupon that only earns on the days you are right

In the app, Digital Option carries a five-step lesson, a worked example and a bank of twelve questions drawn differently every sitting.

Get OTC Learn on Google Play

Educational content only. Nothing here is financial advice, an offer to trade, or a recommendation to buy or sell any instrument.