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
BREAKING DOWN '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.