Demystifying digital options

The digital option is the simplest of all derivatives contracts. At maturity, it either pays out if a certain condition is met or pays out zero if it is not met. Guus Oonincx explains the role digital options play in structured products


The digital is the closest traded option that resembles an ordinary bet. "Do you want to bet, for a keg of beer, that it is going to rain tomorrow?" This bet pays out nothing or a keg of beer, depending on the rain event taking place or not.

Digital options are embedded in a large portion of structured products issued by banks, including autocallable and yield optimisation notes, and reverse convertibles. The digital option is characterised by a jump in payoff, or a discontinuous payoff based on

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