The expected pay-out is equal to the upfront premium and is calculated by multiplying the sum of each of the event payoffs and its probability. In the context of the Fx market, the EP depends on where the underlying price is compared to the strike of this option, these prices are normally distributed. However, payoffs are continuous meaning they are calculated using average payoffs.
Key learning objectives:
Define expected pay-out and how its calculated in the p.d.f context
Explain the focus of models, and how expiry prices are distributed to calculate payoffs.
Identify the reality of calculating EPs in c.r.v form
Understand the assumptions behind ‘Black Scholes’