Financial Instruments to Lock in Payoffs

Abstract

is withJZ? Morgan Securities in New York.A lock-in contract is a forward or option whose terminal payof is determined by the market pricefor the underlying asset at a particular time, but is not paid until a lhter date. In this article we present the basic theory of valuation and hedging for lock-in forwards and both European ang American lock-in options. Pricing European contracts is stra&Jhtjorward, but determining the strategyfor optimal exercise and valuing the option to choose the lock-in date for an American lock-in option introduces an interesting jee-boundary problem into the valuation model. We ofer two ways of solving this problem numerically and compare the values of lock-in puts andcalls with otherurise similar straight options. erivative securities are becoming both more popular and highly exotic. The primary motivations driving the recent innovations may lock in the time T option payoff max[O, K -S,] at a time t(t T). If K > S,, the investor surrenders one share of the stock to the option writer at time T