An upbet can only win or lose at the moment the bet expires and not at

Ant time leading up to the expiry of the bet.

Examples of upbets are :

Will the price of the CBOT US Sep 10 year notes future is above $114 at 1600hrs on the last trading day of August?

Will the bow jones index be above 12,000 at 1600hrs on the last Trading day of the year?

Will the LIFFE Euribor Dec/sep spread be above 10 ticks at settlement on the last day of November?

Will a non-farm payroll number be above +150,000?

Examples  1,  2& 3 enable the bettor to make a minute by minute

Assessment of the probability of the bet winning. Example 4 is a number

(supposdedly) cloaked in secrecy until the number is announced at 13.30

Hrs on a Friday.

In all the above examples the det always has a chance of winning or

Losing right up to the expiry of the bet although the probability may be

Less than 1% or greater than 99% the notes could be trading two full

Points below the strike the day before expiry but it is possible, although

Highly improbable, for them to rise enough during the final day to settle

Above the strike. The day prior to expiry and still lose although the

Probability of losing may be considered negligible.

Ultimately the upbet is not concluded until the bet has officially expired

And until them no winners or losers can be determined .

Downbets too can only win or lose at expiry. Although in many circum-

Stances the downbet  is simply the reverse of the upbet, the downbet has

Been treated with the same methodology as the upbet in order that other

Bets, e.g. the eachwaybet ,can be analysed within a uniform structure.

Also a separate treatment of downbets will provide a firmer base on

Which to analyse the sensitivity of downbets.

1.1 upbet specification

Fig 1.1.1 presents three different random walks that have been generated

In order to illustrate winning and losing bets.  All the upbets start with an

Underlying price of $100, have twenty-five days to expiry and a strike

Price of $101.

Ranadom walk 1 (RW1)flirts with the $101 level after five days,retreats

Back to the $100 level,rises and passes through the $101 strike after

Eighteen days and then drifts to settle at a price around $100. The

Duyer of the upbet loses.

RW2 travels  up to the $101 level after the eighth day where it moves

Sideways until, with nine days to expiry, the underlying resumes its

Upwards momentum.  The underlying continues to rise and is around

The $102.75 level at expiry , well above the strike of $101,so is

Consequently a winning bet with the seller ending the loser .

RW3 drifts sideways from day one and never looks like reaching the

Strike . RW3 is a losing bet for the backer with the underlying settling

Around $ 100. 50 at expiry.

1.2 upbet pricing

Fig 1.2.1 illustrates the expiry priceprofile of an upbet. One of the

Features of binaries is that at expiry price profile of an upbet . one of the

Features of binaries of binaries is that at expiry, bets have a discontinuous distribution,

i.e. there is a gap between the winning and losing bet price . bets don’t

‘almost’ win and settle at, say 99,but are’ black and white ‘; they’ve either

(except in the case of a ‘dead heat’)won or lost and settle at either 100

Or zero respectively.

if the upbet is in –the money , i. e. in the above example of fig 1.1.1 the

Underlying is higher than $101, them the upbet has won and has a

Value of 100.

alternatively   if the upbet is out-of-the-money, i.e. the underlying is lower

Than $ 101, then the upbet has lost and therefore has a value of zero.

In the case of the underlying finishing exactly on the strike price of

$101 , i.e. the updet is at-the money, then the bet may settle at 0,50

Or  100 depending on the rules or contract specification.

Figure 1.2.1

One issuer of binaries may stipulate that there are only two alternatives,

A winning bet whereby the underlying finishes below or exactly on $101.a second company might issue exactly the same bungee but with

The contract specification that if the underlying finishes exactly on the

Strike the bet wins. A third company may consider that the underlying

Finishing exactly

15

bungee options

On the strike is a special case and call it a  ’draw’ , tie’ or’ dead heat’,

Whereby the upbet will settle at 50. This company’s rules therefore allow three possible upbet   settlement   price at the expiry of the bet .

N.B. throughout the examples in this book the latter approach will be

Adopted whereby in the event that a bet is a ‘dead heat’ or in other

Word, where the underlying  is exactly on the strike price at expiry , then

It is settled at 50.

1.3 Upbet profit & loss profile as

The purchaser of a bungee option , just tike a conventional

Option, can only lose the amount spent on the premium if trader a paid 40 for an updet at $1 per point then trader a can lose a maximum

Of just 40x $1 = $40. But with a bungee not only the loss has a maximum limit but the potential profit has a maximum limit also. So  although trader A’s loss is limited to $40, his profit is limited to (100-40)x$1= $60. As a general rule the profit and loss of the buyer and seller of any

bungee must sum to 100x$ per point.

In figs 1.3.1 and 1.3.2 respectively trader A’s and trader B’s P&L

Profiles are illustrated . both traders are taking opposite

Views on whether a share

Price will be above $ 101 at the expiry of the upbet.

In fig 1.3.1 trader a has bought the upbet at a price of 40 for $1

Per point ($1/pt) so his three possible outcomes are:

Trader A loses $40 at any level of the underlying below

$101

AT $101 the rules of this particular upbet determine a ‘dead heat’

Has taken place and the upbet settles at 50 with trader a making a profit of $10.

Above $101 trader a wins outright and the upbet is settled at 100 to

Generate a profit of $60.

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Upbets and bownbets

The expiry P&L profile of trader a having gone long an

Upbet with a price of 40 at $1 per point

Figure 1.3.1

Trader B has sold this upbet at 40 for $1/pt so conversely trader B’S P&L   profile is   , as one would expect   , the mirror image of trader A’S reflected through the horizontal axis.

the    Expiry  P&L profile of trader B having gone short an

updet with a price of 40 at $1 per point

trader    B’S   three possible outcome are:

Trader  B has sold 40s and therefore wants to see the underlying below $ 101 where the upbet is worth zero at expiry and trader B collects the premium of 40 x $1 =$40 .

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Bungee options

If the upbet settles at –the-money the upbet is worth 50 and trader B loses $10 having gone ’short’ $1/pt at 40.

The underlying is above $101 at the upbet’s expiry so trader B loses outright to the tune of $ 60.