What Is an Asset-Or-Nothing Call Option?

An asset-or-nothing call is a type of digital option whose payout is fixed after the underlying asset exceeds the predetermined threshold or strike price. The payout depends only on whether or not the underlying asset closes above the strike price - in the money - at the expiration date. It does not matter how deep in the money as the payout is fixed.

Key Takeaways

  • Asset-or-nothing options settle with the physical delivery of the underlying asset if the option expires in the money.
  • These options are digital or binary, meaning they pay a predetermined payout or zero.
  • Asset-or-nothing options can be a simplified risk hedge.

How an Asset-Or-Nothing Call Option Works

Asset-or-nothing calls and asset-or-nothing puts either pay or they don't pay a fixed amount dependent only on the final expiration being in the money or not (hence the term "digital"). As such it can be an effective hedging mechanism under the right circumstances because it makes for a simplified risk and payout structure.

As the name suggests, asset-or-nothing options settle with the physical delivery of the underlying asset. Although all digital options (sometimes referred to as binary options) may sound simple, they differ from standardized options for most securities and may be traded on unregulated platforms. Therefore, they may carry a higher risk associated with an illiquid underlying.

They may also be more susceptible to use by those engaging in fraudulent activity. Investors who wish to invest in binary options should use platforms that are regulated by the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) or other regulators.

Because the workings of any digital option resemble the simplicity of placing a casino bet, they carry a stigma of being similar to a gambling instrument. But the stigma alone does not eliminate the legitimate use of such an instrument.

However most market participants prefer the standard options which pay on a sliding scale so the deeper in the money they move, the higher the payout, this makes their hedge more accurately connected with price movement.

There are other types of binary options including cash-or-nothing calls and cash-or-nothing puts. As the names suggest, they settle with in cash. And since they are digital, i.e. all or none, if the underlying price is above the strike price, it pays the underlying price. If it is not above the strike then the payoff is zero.

Example

For example, assume the gold currently trades at $1,260 per ounce at 12:45 p.m., on June 2. A trader is bullish on gold and believes that it will trade above $1,275 before the end of that trading day on June 2. The trader purchases 10 gold $1,275 asset-or-nothing call options at 12:45 p.m. If gold closes above $1,275 at the end of the trading day, on June 2, the trader would receive 10 contracts worth of gold. If gold fails to close above $1,275, the trader loses the entire investment.

Closing just slightly in the money is all the call holder needs to profit. If the trader believes the underlying asset will close significantly higher than the strike price then standard option may be a better choice since it allows the holder to participate in that gain. The cost should also be lower.

Exercise Style

Binary options are either American Style or European Style depending on the individual market and the underlying asset.

American Style digital option automatically exercise the moment they get in the money, unlike American style standard options. This means that the holder gets the payoff immediately instead of waiting for expiration. This is similar to one-touch options.

European Style digital options only exercise at expiration. Most digital options are in the European Style.