Compound Option

A compound option is an option on an option — giving the holder the right, but not the obligation, to buy or sell another option at a specified price on or before a specific date. There are four types: call on a call, call on a put, put on a call, and put on a put. Compound options are used when an investor is uncertain whether they will actually need the protection of an option but wants to secure the right to obtain it cheaply. For instance, a corporate treasurer expecting a potential foreign currency need in six months may buy a call on a USD/INR call option, paying a small upfront premium now rather than committing to the full option premium. Compound options are OTC instruments and involve two separate expiry dates and two separate strike prices.