Contingent Premium Option

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table2"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table3"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">Contingent Premium Option</td> <td width="45" align="right" valign="bottom"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" width="45" height="12"></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table4"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="100%" align="left" valign="top"><p class="word_list"> <a href="#contingent premium option">contingent premium option</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="165" align="left" id="table5"> <tr> <td width="160">  </td> <td width="11"> </td> </tr> <tr> <td width="160"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script> </td> <td width="11"> </td> </tr> </table> <p class="body"><strong style="font-weight: 400">A </strong><strong> <a name="contingent premium option">contingent premium option</a></strong><strong style="font-weight: 400"> is a <a href="../articles/option.htm">European</a> <a href="../articles/option.htm">option</a> whose <a href="../articles/time_value_and_intrinsic_value.htm">premium</a> is deferred to <a href="../articles/option.htm">expiration</a> and is paid only if the option expires <a href="../articles/time_value_and_intrinsic_value.htm">in-the-money</a>. If it expires at-the-money or out-of-the-money, no premium is paid and the option expires worthless.</strong></p> <p class="body">The <a href="../articles/time_value_and_intrinsic_value.htm">expiration value</a> (which equals the <a href="../articles/options_spread.htm">payoff</a>) of a contingent premium <a href="../articles/option.htm">call</a> is shown in Exhibit 1:</p> <div align="center"> <center> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="300" cellpadding="0" id="table6"> <tr> <td> <p class="exhibit_header"><span class="exhibit_header">Expiration Value of a <br> Contingent Premium Call</span><br> <span class="exhibit_subheader">Exhibit 1</span></td> </tr> <tr> <td bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td> <img border="0" src="../images/ex1_contingent_premium_option.gif" width="300" height="133"></td> </tr> <tr> <td> <p class="exhibit_legend">A premium is paid for a contingent premium option only if it expires in-the-money. This will result in a loss if the option expires only slightly in-the-money, as is illustrated for a contingent premium call in this exhibit.</td> </tr> </table> </center> </div> <p class="body">Obviously, the holder of the option will lose money if the option expires only slightly in the money. The purchaser is betting that the option will either not expire in the money or that it will expire far in the money. </p> <p class="body">A derivatives dealer can assemble a contingent premium option from more simple instruments. For example, a contingent premium call can be assembled by selling a <a href="../articles/binary_option.htm">cash-or-nothing binary</a> call option and using the proceeds to purchase a <a href="../articles/option.htm">vanilla</a> call. The contingent premium option can be priced by valuing the constituent parts.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table7"> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table8"> <tr> <td width="100%"> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/derivative_instrument.htm">d</a></strong><a href="../articles/derivative_instrument.htm"><strong style="font-weight: 400">erivative instrument</strong></a><strong style="font-weight: 400"> An instrument which derives its value from the value of other financial instruments. 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