Compound Option

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DEFINITION of 'Compound Option'

An option for which the underlying is another option. Therefore, there are two strike prices and two exercise dates. These are the four types of compound options:

- Call on a call
- Put on a put
- Call on a put
- Put on a call

INVESTOPEDIA EXPLAINS 'Compound Option'

This type of option usually exists for currency or fixed-income markets, where an uncertainty exists regarding the option's risk protection capabilities. The advantages of compound options are that they allow for large leverage and they are cheaper than straight options. However, if both options are exercised, the total premium will be more than the premium on a single option.

RELATED TERMS
  1. Call

    1. The period of time between the opening and closing of some ...
  2. Front Fee

    The option premium paid by an investor upon the initial purchase ...
  3. Leverage

    1. The use of various financial instruments or borrowed capital, ...
  4. Back Fee

    A payment made to the writer of a compound option in the case ...
  5. Exotic Option

    An option that differs from common American or European options ...
  6. Underlying

    1. In derivatives, the security that must be delivered when a ...
RELATED FAQS
  1. What's the difference between a regular option and an exotic option?

    Before learning about exotic options, you should have a fairly good understanding of regular options. Both types of options ... Read Full Answer >>
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