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Exotic Options
In
finance, an exotic option is a
derivative which has features making it more complex
than commonly traded products (vanilla options). These
products are usually traded over-the-counter (OTC), or
are embedded in structured notes.
Consider
an equity index. A straight call or put, either American
or European would be considered non-exotic (vanilla).
An exotic product could have one or more of the following
features:
- The
payoff at maturity depends not just on the value of
the underlying index at maturity, but at its value at
several times during the contract's life (it could be
an Asian option depending on some average, a lookback
option depending on the maximum or minimum, a barrier
option which ceases to exist if a certain level is reached
or not reached by the underlying, a digital option,
range options, etc.)
- It
could depend on more than one index (as in a basket
options, Himalaya options or other mountain range options,
outperformance options, etc.)
- There
could be callability and putability rights.
- It
could involve foreign exchange rates in various ways,
such as a quanto or composite option.
Even
products traded actively in the market can have the characteristics
of exotic options, such as convertible bonds, whose valuation
can depend on the price and volatility of the underlying
equity, the credit rating, the level and volatility of
interest rates, and the correlations between these factors.
Exotic
options can pose challenging problems in valuation and
hedging.
Examples
Further
reading
- Haug,
Espen Gaarder (2007). The Complete Guide to Option
Pricing Formulas. New York: McGraw-Hill. ISBN 0-07-147734-9.
- Banks,
Erik; Paul Siegel (2007). The Options Applications
Handbook: Hedging and Speculating Techniques for Professional
Investors. New York: Wiley. ISBN 0-07-145315-6.
- Kyprianou, Andreas E.; Wim Schoutens, Paul Wilmott
(2005). Exotic Option Pricing and Advanced Levy Models.
Hoboken, NJ: John Wiley & Sons. ISBN 0-470-01684-1.
- Rebonato,
Riccardo (1998). Interest-rate Option Models: Understanding,
Analysing and Using Models for Exotic Interest-rate
Options. New York: McGraw-Hill. ISBN 0-471-97958-9.
External
links
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