Static hedging of chained-type barrier options

Abstract

This paper concerns barrier options which are chained together. When the underlying asset price hits a certain barrier level, another barrier option is given to a primary option holder. Then, if the asset price hits another barrier, a third barrier option is given, and so on. The paper studies the hedging problem for these chained-type barrier options. We use the (double) reflection principle and propose a static replication portfolio of vanilla options for hedging of these options in the Black–Scholes model. The Monte Carlo simulation results for vanilla options with adjusted payoffs are provided to demonstrate the accuracy of the hedging strategies. A comparison between static hedging and delta hedging for a chained barrier option shows static hedge performs better than delta hedge.