One-Touch and Digital Options: A Binary Payoff With Awkward Hedging

[Shadow Trader]

A digital option pays a fixed amount if spot finishes beyond a strike at expiry. A one-touch pays if spot touches a level at any moment before expiry. Both are binary, meaning the payoff is all or nothing, unlike ordinary options whose value changes gradually.

The hedging difficulty comes from that sharp edge. Near the strike close to expiry, a digital's delta becomes very large, because a tiny spot move flips the payoff from nothing to the full amount. Replicating it with spot alone would require an enormous and rapidly changing hedge. In practice, desks often approximate a digital with tight call or put spreads, which cap the size of the exposure, and may build a safety margin into the quoted price.

Pin risk is the related headache. At expiry, whether spot sits just above or just below the strike decides the entire payout, so the final minutes can be unusually sensitive for a desk holding sizable binaries.

For scalpers, such exposure is mostly invisible. It does illustrate that payoffs with sharp edges concentrate hedging near one price at one time, which can produce brief, jumpy behavior around expiry. Retail binary products offered on some platforms are a separate matter and are not interchangeable with the interbank instruments described here, so their terms deserve careful reading.