A rainbow option (also known as an either-or option or an alternative option) whose payoff is based on the performance of two different underlying assets. This type of option is widely used in the stock markets, and it allows investors to earn the return associated with the better performing of two stocks or indexes. Though it usually involves assets from a specific asset class such as all-stock, it can also involve assets from different classes such as stocks and bonds.
Put another way, the best-of-two-assets option is a linear multi-asset option whose payoff is determined by the highest difference between the prices of two underlying assets.
It commonly belongs to the class of exchange options.
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