Pattern derivatives

In this paper, we propose a new type of derivative called a pattern derivative. In the simple case of an asset that moves up u or down d in value, a pattern is a sequence of {u, d} movements that may occur before expiration. We provide general pricing formulas that rely on a brute force approach as well as efficient valuation algorithms based on recursive formulas for the probability of patterns to occur. We generalise our results to exclusive, inclusive, and multi-pattern options. Finally, we discuss the possible benefits of this type of options.