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Exotic Options

This document defines and describes various types of exotic options. Exotic options are non-standard derivative products created by financial engineers beyond the plain vanilla European and American call and put options. It lists and provides brief explanations of different categories of exotic options, including package options, nonstandard American options, forward start options, compound options, chooser options, barrier options, binary options, lookback options, shout options, and Asian options.

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Prasad Nayak
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206 views

Exotic Options

This document defines and describes various types of exotic options. Exotic options are non-standard derivative products created by financial engineers beyond the plain vanilla European and American call and put options. It lists and provides brief explanations of different categories of exotic options, including package options, nonstandard American options, forward start options, compound options, chooser options, barrier options, binary options, lookback options, shout options, and Asian options.

Uploaded by

Prasad Nayak
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Exotic Options.

Derivatives such as European and American Call and put options are termed as
plain Vanilla options. They have standard well defined properties and trade actively.
One of the exciting aspects of the OTC market is the number of non standard
products that have been created by financial engineers. These are termed exotic
options.
Types of Exotic Options
Package
Nonstandard American options
Forward start options
Compound options
Chooser options
Barrier options
Binary options
Lookback options
Shout options
Asian options
Packages

Portfolios of standard options i.e. European call, put, Forward contracts, cash,
underlying.
Examples bull spreads, bear spreads, straddles, etc.
Often structured to have zero cost
One popular package is a range forward contract. It consists of a long call and
a short put or a short call and long put.

Nonstandard American options

Exercisable only on specific dates (Bermudans)


Early exercise allowed during only part of life (initial lock out period)
Strike price changes over the life (warrants, convertibles)

Forward start options

Option starts at a future time, T1


Implicit in employee stock option plans
Often structured so that strike price equals asset price at time T1
Compound options
Option to buy or sell an option

Call on call

Put on call

Call on put

Put on put

Can be valued analytically


Price is quite low compared with a regular option
Chooser Option(As you like it)
Option starts at time 0, matures at T2
At T1 (0 < T1 < T2) buyer chooses whether it is a put or call
This is a package!
Barrier Options

Option comes into existence only if stock price hits barrier before option
maturity
In options
Option dies if stock price hits barrier before option maturity
Out options
Stock price must hit barrier from below
Up options
Stock price must hit barrier from above
Down options
Option may be a put or a call
Binary Options

Binary options are options with discontinuous pay off. Example Cash or
Nothing call.
Another binary option is asset or nothing call.
Similarly for put option

LookBack Options
Floating lookback call pays ST Smin at time T (Allows buyer to buy stock at
lowest observed price in some interval of time)
Floating lookback put pays Smax ST at time T
(Allows buyer to sell stock at highest observed price in some interval of
time)
Fixed lookback call pays max(SmaxK, 0)
Fixed lookback put pays max(K Smin, 0)
Shout Option
Buyer can shout once during option life
Final payoff is either
Usual option payoff, max(ST K, 0), or
Intrinsic value at time of shout, St K
Payoff: max(ST St , 0) + St K
Similar to lookback option but cheaper
Asian Option
Payoff related to average stock price
Average Price options pay:

Call: max(Save K, 0)

Put: max(K Save , 0)

Average Strike options pay:

Call: max(ST Save , 0)

Put: max(Save ST , 0)

References
John Hull Chapter 24 Exotic options

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