Pricing Onion Options : A Probabilistic Approach

Upmann, Thorsten

As argued by Ebenfeld, Mayr and Topper (2002), Onion options may be decomposed into one-touch double barrier binary options (ODBs). Using this idea, these authors provide an arbitrage-free pricing formula for Onion options within the Black-Scholes framework. Their approach rests upon solving the underlying partial differential equation. In this paper, we take an alternative and more direct route: Based on a probabilistic approach, we compute the risk-neutral valuation formula for an ODB. Then, by inverting the decomposition of an Onion option, we are able to derive an alternative pricing formula for this type of an option.

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Upmann, T., 2018. Pricing Onion Options: A Probabilistic Approach. https://doi.org/10.5430/ijfr.v4n4p11
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