A compound option or split-fee option is an option on an option. The exercise payoff of a compound option involves the value of another option. A compound option then has two expiration dates and two strike prices. Usually, compounded options are used for currency or fixed income markets where insecurity exists regarding the option’s risk protection. Another common business application that compound options are used for—to hedge bids for business projects that may or may not be accepted.
Compound options provide their owners with the right to buy or sell another option. These options create positions with greater leverage than do traditional options. There are four basic types of compound options: