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Digital Option

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A digital option is a type of exotic options which offers a fixed payout if the underlying instrument price exceeds a pre-specified strike price (i.e. digital call option). If the digital option is a put, the lump-sum cash payment will occur if the underlying instrument price drops below the pre-specified strike price (i.e. digital put option). The fixed payout amount is set at the time the digital option is purchased and is the same regardless of the amount by which the price of the underlying security rises above the strike price (i.e. if the digital option is a call) or falls below the strike price (if the digital option is a put). A digital option is also called a binary option. A digital option can trade either OTC (over-the-counter) or on an exchange such as the CBOE (Chicago Board Options Exchange). A digital option will generally be a European option, meaning that it may only be exercised at the date of expiration. For example, a digital call option on stock ABC with a strike of $100 and a payout of $50 means that if at the time of expiration, ABC trades above $100, then the investor will receive $50. On the downside, this digital option will payout nothing if ABC trades below $100 (a digital option is also be referred to as an all-or-nothing option). On occasion, a digital option may also be traded as an American-style option. In this case, an american digital call option on stock ABC will payout when and if stock ABC exceeds $100 at any point from the time of purchase up until the expiration date.

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