Compound Option

An option on another option-it gives the holder the right, but not the obligation, to buy or sell a second option at a set price and time. These are used in more complex hedging strategies where the underlying exposure is uncertain or may not materialize.

For example, a company bidding on an overseas contract might use a compound call option to secure the right to buy a currency option later-only if the contract is awarded. This avoids paying for a hedge before the need is confirmed. 

Compound options are considered exotic options and are often used when timing and uncertainty are key factors. They’re closely related to contingent options, vanilla options, and strategies that aim to control cost and maintain flexibility in dynamic environments.