COMMON TYPES OF EXOTIC OPTIONS

Exotic options are exciting and complex. They aren’t plain “vanilla” options by any means.

I’ve recently written a couple of posts about exotic options. Now I will set out some common types.

Common Types of Exotic Options:

► ASIAN OPTIONS: These options derive their payoff from the average price of the underlying asset over a given timeframe, lessening the effect of short-term volatility.

► BARRIER OPTIONS: These options become active ("knock-in") or inactive ("knock-out") when the underlying asset's price hits a specified barrier during the option's duration.

► UP-AND-IN/ DOWN-AND-IN: Activate when the price rises to/falls to a certain barrier.

► UP-AND-OUT/ DOWN-AND-OUT: Become worthless when the price rises to/falls to a certain barrier.

► BINARY OPTIONS (DIGITAL OPTIONS): Provide a fixed payout if a defined condition (e.g., the underlying asset's price surpassing or falling below a set level at expiration) is fulfilled; otherwise, they yield no payment.

• LOOKBACK OPTIONS: Enable the holder to "look back" at a designated period and select the most advantageous price (highest for calls, lowest for puts) as the strike price, granting significant flexibility.

• CHOOSER OPTIONS: Allow the holder to decide, on a predetermined future date, whether the option will be a call or a put.

• COMPOUND OPTIONS: These are “options on options,” meaning the underlying asset of the option is another options contract.

• BASKET OPTIONS: Their payoff is based on the performance of a weighted average of various underlying assets (a "basket" of securities).

• BERMUDA OPTIONS: Can be exercised on specific predetermined dates between the purchase and expiration dates, resulting in a blend of American and European option exercise styles.

• QUANTO OPTIONS: These permit exposure to a foreign asset while maintaining a fixed exchange rate in the investor's home currency, thus eliminating currency risk.


In the next and final post of this series, I’ll weigh the benefits and risks of exotic options.