Vanilla option
Family I · Instruments
Not to be confused with binary option.
Vanilla option is the plain, exchange-traded or over-the-counter contract that most other options are compared against. It comes in two basic forms, a call (the right to buy) and a put (the right to sell), and its payoff varies continuously with the price of the underlying. The term distinguishes it from options with non-standard features such as barriers, averaging or digital settlement.
Payoff and pricing
The value of a vanilla option at expiry is its intrinsic value: for a call, the greater of zero and the underlying price minus the strike; for a put, the greater of zero and the strike minus the underlying price. Before expiry, the option also carries time value, which depends on volatility, time remaining, interest rates and any dividends. Standard pricing models, such as Black-Scholes or binomial trees, assume continuous prices and no early exercise for European-style contracts.
Worked example
A European call option on a stock gives the right to buy 100 shares at a strike of 50.00. At expiry the stock trades at 57.25. The option is exercised and the gross payoff is calculated as follows.
Variants and conventions
Vanilla options may be European, exercisable only at expiry, or American, exercisable at any time up to expiry. They trade on organised exchanges and in over-the-counter markets. Contract size, settlement method, exercise style and expiry conventions vary by market and by contract specification, so the terms of any particular option are set by the exchange or the counterparties rather than by a universal standard.
Often confused with
- binary option
- A vanilla option pays an amount that changes with the underlying price, while a binary option pays a fixed amount if a condition is met and nothing otherwise; the visible sign is the all-or-nothing payoff profile of the binary.