What is the safest option trade?

What is the safest option trade?


The simplest derivative securities have payoffs that are European-style and path-independent, eg. vanilla calls and puts.

Next up in complexity are payoffs which are European-style but path-dependent eg. lookback or Asian options.

The next level of complexity are payoffs which are Bermudan-style, but path independent eg Bermudan swaptions.

An even greater level of complexity arises when payoffs are both Bermudan-style and path-dependent. In this paper, we introduce a naturally arising new derivative security whose payoff is both Bermudan-style and path-dependent. We call this derivative security a stoption. The name arises because the owner has optionality over when to stop an exposure to price changes in some underlying reference security.

After paying an upfront premium. The owner of a stoption accrues realized price changes in the underlying reference security. Until the exposure is stopped. By the owner. Furthermore, upon stopping, the reward is the sum of all of the previous price changes in the underlying plus a deterministic amount called a floor. The floor received upon stopping can vary with the stopping time selected by the owner of the stoption.

The floor can be regarded. As a replacement for the just realized price change. Moreover, one that would have accrued had the owner not stopped, but rather continued. Lastly, stoptions are finite-lived, and hence must be stopped at or before a fixed maturity date.

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What is the safest option trade?