Mountain Range Options

What Are Mountain Range Options?

Mountain range options are a family of exotic options based on multiple underlying securities. Mountain range options were first marketed by French securities firm Société Générale in 1998. These options blend some of the key characteristics of basket-style or rainbow options — both of which have more than one underlying security or asset — and range options with multiyear time ranges.

Understanding Mountain Range Options

Options are derivatives. Their values are based on the value of the underlying asset they represent such as stocks. With an options contract, the investor has the opportunity — but not the obligation — to buy or sell the underlying asset on or before a predetermined date.

Options can vary, ranging from vanilla to exotic options. Vanilla options are common among different types of investors who want to hedge their bets when it comes to certain assets. Exotic options may be more complicated because their expiration dates, prices, and other characteristics are different and tend to be far more complicated than traditional options.

Mountain range options are exotic options. While a regular option involves a single underlying asset, a mountain range option combines numerous underlying assets into one option. Trading generally happens over-the-counter (OTC) by financial institutions and private, institutional investors. Mountain range options take features from both basket options and range options — the former represents a basket or group of assets, while the latter allows traders to benefit from the difference between the high and low level of the option. The performance of the underlying assets plays a big part in the payoff an investor receives.

The price of a mountain range option is based on multiple variables, the most important of which are the correlations between the individual securities in the basket. Some options have discrete payout levels, such as double the investment or triple the investment, if certain performance metrics are hit by the underlying securities while the option is in effect.

Mountain range options cannot be priced with standard closed-form approaches. These exotic instruments instead require Monte Carlo simulation methods. Effects such as volatility skew, which is found in most options, can be even more pronounced within mountain range options.

Special Considerations

It can often be difficult to determine the fair market value (FMV) of these exotic options. That's because applying standard formulas is nearly impossible. Certain types of mountain range options have recalculation or sampling dates, at which the best- or worst-performing stocks from the basket are removed. Therefore, options holders must constantly re-evaluate the parameters affecting their current or present value (PV).

Given their esoteric nature, how can mountain range options be traded? A good example might include a scenario when a hedger prefers not to monitor multiple options written on individual assets. A basket option can provide the same protection by covering several positions with a single derivative.

This approach's combined volatility may be lower than the net volatility of individual assets, thereby resulting in an otherwise lower option price, which can be costly for a rather sophisticated position. These features helped make mountain range options an attractive option for traders seeking a reasonably priced strategy requiring minimal capital guarantees.

Types of Mountain Ranges

Mountain range options are named after a series of mountains, each representing a different type of contract. Some of the most common include: