1a. In your own simple word, explain the difference between path-dependent optio

Question

1a. In your own simple word, explain the difference between path-dependent options and path-independent options and GIVE EXAMPLES of each

1b. Not more than 3 lines, comment on or add to the classmate posting.

Classmate posting:

Path-dependent options are where the path of the underlying asset has an impact on the price of the option. The underlying asset will often fluctuate in price over the life of the option. If the option is path-dependent, these fluctuations can have an impact on the price of the option itself. American options are considered path-dependent because they may be exercised early based on performance of the underlying asset. Another path-dependent option is the lookback option, in which a call would allow you to buy the asset at the lowest price over the life of the option and vice versa for a put (pg. 500 -501).

Path-independent options are where the path of the underlying asset does not have an impact on the price of the option. European options are considered path-independent because they can only be exercised at expiration, making the path followed during the life of the option irrelevant.

Explanation / Answer

Path Dependent Options:

The right, but not the obligation, to buy or sell an underlying asset at a predetermined price during a specified time period, where the price is based on the fluctuations in the underlying's value during all or part of the contract term. A path dependent option's payoff is determined by the path of the underlying asset's price.

A basic American option is one type of path dependent option. Because it can be exercised at any time prior to expiration, its value will change as the underlying asset's value changes. An Asian option, also called an average option, is another type of path dependent option, because its payoff is based on the average price of the underlying asset during the contract term. Similarly, a barrier option would be considered a path dependent option because its value changes if the underlying asset reaches or surpasses a specified price. The lookback option and Russian option are also path-dependent options.

Path Independent options:

An option whose payoff depends solely on the events specified to take place upon expiration, rather than the path taken by the underlying variable (price, rate, index, etc). A prime example is a European option where the price for the buyer depends exclusively on the terminal price. If an investor buys a call option with a strike price of USD 50, he would benefit if the underlying rises above 50 upon expiration. If not, he would not exercise and the premium paid to buy the option is lost. It is irrelevant which route the underlying price (the sport price of the option's underlying asset) takes within time to expiration.

This option, opposite of path-dependent option, is also referred to as non-path-dependent option.

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