Definition

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

What is 'Rainbow Option'

A single option linked to two or more underlying assets. In order for the option to pay off, all the underlying assets must move in the intended direction.

Explaining 'Rainbow Option'

The underlying securities can have different characteristics, such as expiry date and strike price, but all must move in the way the option holder has bet they will.

Here's a sports-betting analogy that demonstrates a rainbow option: suppose you're at a baseball tournament with three fields backing one another. One game is halfway through, a second is just starting and a third starts in an hour. A type of bet that's analogous to a rainbow option is one that earns you a profit if you pick all three winners, but gets you nothing if any one team you pick is a loser.

Further Reading

Continuous rainbow options on commodity outputs: what is the real value of switching facilities?
www.tandfonline.com [PDF]
… Thanks to the 2005 Mathematics of Finance class at the University of the Witwatersrand for alert … A rainbow option with n assets will require the n-variate cumulative normal function for application … of (Genz 2004), so here we apply this code to European rainbow options with three …

Valuing a multi-product mining project by compound rainbow option analysis
www.tandfonline.com [PDF]
… Thanks to the 2005 Mathematics of Finance class at the University of the Witwatersrand for alert … A rainbow option with n assets will require the n-variate cumulative normal function for application … of (Genz 2004), so here we apply this code to European rainbow options with three …

A pricing model of fuzzy rainbow options
ieeexplore.ieee.org [PDF]
… Thanks to the 2005 Mathematics of Finance class at the University of the Witwatersrand for alert … A rainbow option with n assets will require the n-variate cumulative normal function for application … of (Genz 2004), so here we apply this code to European rainbow options with three …

[J]' src='/thumbnails/?img=http%3A%2F%2Fen.cnki.com.cn%2FArticle_en%2FCJFDTotal-HFXZ200604009.htm' />A Study on the Rainbow Option Pricing Model with Transaction Costs [J]
en.cnki.com.cn [[J]' href='https:/api.miniature.io/pdf?url=en.cnki.com.cn%2FArticle_en%2FCJFDTotal-HFXZ200604009.htm'>PDF]
… Thanks to the 2005 Mathematics of Finance class at the University of the Witwatersrand for alert … A rainbow option with n assets will require the n-variate cumulative normal function for application … of (Genz 2004), so here we apply this code to European rainbow options with three …

Fractional white noise calculus and applications to finance
www.worldscientific.com [PDF]
… Thanks to the 2005 Mathematics of Finance class at the University of the Witwatersrand for alert … A rainbow option with n assets will require the n-variate cumulative normal function for application … of (Genz 2004), so here we apply this code to European rainbow options with three …

Sequential real rainbow options
www.tandfonline.com [PDF]
… Thanks to the 2005 Mathematics of Finance class at the University of the Witwatersrand for alert … A rainbow option with n assets will require the n-variate cumulative normal function for application … of (Genz 2004), so here we apply this code to European rainbow options with three …

Valuing an Early‐Stage Biotechnology Investment as a Rainbow Option
onlinelibrary.wiley.com [PDF]
… Thanks to the 2005 Mathematics of Finance class at the University of the Witwatersrand for alert … A rainbow option with n assets will require the n-variate cumulative normal function for application … of (Genz 2004), so here we apply this code to European rainbow options with three …

Q&A About Rainbow Option