# Futures and options trading meaning of colors

Rainbow option is a derivative exposed to two or more sources of uncertainty[1] as opposed to a simple option that is exposed to one source of uncertainty, such as the price of underlying asset.

The name of rainbow comes from Rubinstein [2]who emphasises that this option was based on a combination of various assets like a rainbow is a combination of various colors. More generally, rainbow options are multiasset options, also referred to as correlation options, or basket options.

Rainbow can take various other forms but the combining idea is to have a payoff that is depending on the assets sorted by their performance at maturity. When the rainbow only pays the best respectively worst performing asset of the basket, it is also called best-ofrespectively worst-of. Other popular options that can be reformulated as a rainbow option are spread and exchange options.

Rainbow options are usually calls or puts on the best or worst of n underlying assets. Another example is an option that includes more than one strike on more than one underlying asset with a payoff equivalent to largest in-the-money portion of any of the strike prices. The options are often considered futures and options trading meaning of colors correlation trade since the value of the option is sensitive to the correlation between the various basket components.

Rainbow options are used, for example, to value natural resources deposits. Such assets are exposed to two uncertainties— price and quantity. Some futures and options trading meaning of colors options can be transformed into more complex instruments if the underlying risk model that the option reflected does not match a future reality. In particular, derivatives in the currency and mortgage markets have been subject to liquidity risk that was not reflected in the pricing of the option when sold.

Rainbow options refer to all options whose payoff depends on more than one underlying risky asset; each asset is referred to as a color of the rainbow.

Examples of these include: Rainbow options are usually priced using an appropriate industry-standard model such as Black—Scholes futures and options trading meaning of colors each individual basket component, and a matrix of correlation coefficients applied to the underlying stochastic drivers for the various models.

While there are some closed-form solutions for simpler cases e. For bibliography see Lyden From Wikipedia, the free encyclopedia. Bond and money markets: University of California at Berkeley, Options, futures, and other derivatives. Energy derivative Freight derivative Inflation derivative Property derivative Weather derivative. Futures and options trading meaning of colors from " https: Options finance Economics and finance stubs.

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