EXOTIC OPTIONS

- Kamya 17118
CHARACTERISTICS
● Different from traditional options in their PAYMENT STRUCTURE,
EXPIRATION DATES, and STRIKE PRICES
● HYBRID of American and European options
● CUSTOMISABLE to meet the risk tolerance and desired profit of the investor
● Usually trade in Over-the-counter (OTC) market
● Trading commodities include lumber, corn, oil, and natural gas as well as
equities, bonds, and foreign exchange
Pros and Cons
Pros
● Usually have lower premiums
than the more-flexible American
options
● Customisable
● Can be customized to meet risk
tolerance and desired profit of
investors
● Can help offset risk in a portfolio
● Wide variety of investment
products
Cons
● Some exotic options can have
increased cost due to added
features
● Do not guarantee a profit
● The reaction of market moves for
exotic to market events can be
different from traditional options
● Can’t be priced easily
● More complex
TYPES OF EXOTIC
OPTIONS
➔ Chooser option
➔ Compound option
➔ Barrier option
➔ Look Back option
➔ Bermuda option
➔ Shout option
➔ Asian option
➔ Basket option
 ➢ Allows the holder to decide whether
option will be exercised as a call or
put
➢ Usually European style, with one
strike price and one expiration date
➢ Can be exercised only on expiration
1. Chooser option date
➢ Highly attractive when the
underlying asset sees increase in
volatile
➢ Expensive than European Vanilla
option, as high implied volatility will
increase the premium
Example:
Strike price = $30
Premium = $2
1. If spot price > strike prie, the option will be excersied as a CALL OPTION.
2. If spot price < strike price, the option will be excersied as a PUT OPTION.
Spot Price Net P/L, Call option Net P/L, Put option

27 - +1

28 - 0

29 - -1

30 0 0

31 -1 -

32 0 -

33 +1 -
➔ Receives another option as an
underlying option
➔ Underlying is the second option,
while the initial option is called
overlying
➔ Can involve two strike prices and two
exercise dates, and if exercised then
two premiums
2. Compound option
➔ Combinations can be: call on a put
(CoP); call on a call (CoC); put on a
call (PoC); put on a put (PoP)
➔ Allow for large leverage
➔ Cheaper, initially, than straight
options
Example:

Let’s assume Mr. A buys a call on an option to purchase 100 shares of Company
XYZ at $25 per share by March 31. He pays $1,000 to the seller of that call. This
arrangement is called a compound option -- that is, it is an option to purchase an
option.

Now let’s say Mr. A wants to exercise the call on the option. Now he must pay the
premium on the second option (the option to buy 100 shares of Company XYZ at
$25 per share). This second premium, called the back fee, is $3,900.
 ➔ Become activated or extinguished when the
underlying asset hits a preset price level
➔ commonly traded in the foreign exchange
and equity markets
➔ when the price of the underlying security

3. Barrier option
reaches a specified barrier during the
option's life, rights associated with KNOCK-
IN option comes into existence
➔ KNOCK-OUT barrier options cease to exist
if the underlying asset reaches a barrier
during the life of the option
➔ they tend to have cheaper premiums than
comparable options with no barriers
➔ used to hedge positions
 KNOCK-IN
1. Once a barrier is knocked in, or comes into
existence, the option remains in existence
until it expires
2. Knock-in options may be classified as up-
and-in or down-and-in
3. In an up-and-in barrier option, the option
only comes into existence if the price of the
underlying asset rises above the pre-
specified barrier, which is set above the
underlying's initial price
4. A down-and-in barrier option only comes
into existence when the underlying asset
price moves below a predetermined barrier
that is set below the underlying's initial
price.
KNOCK-OUT
1. Knock-out barrier options cease to exist if
the underlying asset reaches a barrier
during the life of the option.
2. Knock-out barrier options may be classified
as up-and-out or down-and-out
3. An up-and-out option ceases to exist when
the underlying security moves above a
barrier that is set above the underlying's
initial price.
4. A down-and-out option ceases to exist when
the underlying asset moves below a barrier
that is set below the underlying's initial
price. If an underlying asset reaches the
barrier at any time during the option's life,
the option is knocked out, or terminated.
Example:
Let's say a barrier option has a knock-out price of $100, and a strike price of $90
and the stock is currently trading at $80 per share. The option will behave like a
standard option when the underlying is below $99.99, but once the underlying
stock price hits $100, the option gets knocked-out and becomes worthless.

A knock-in would be the opposite. If the underlying is below $99.99, the option
does not exist, but once the underlying hits $100, the option comes into existence
and is $10 in-the-money.
➔ Traders receive a payout if the binary
option expires in the money (ITM) and
incur a loss if it expires out of the money
(OTM).
➔ Depend on the outcome of a "yes or no"
proposition
➔ Have an expiry date and/or time.
➔ Automatically exercises, meaning the
gain or loss on the trade is automatically
4. Binary option
credited or debited to the trader's account
when the option expires
➔ Typically specify a fixed maximum
payout, while maximum risk is limited to
the amount invested in the option
Example:
A binary option may be as simple as whether the share price of ABC will be above
$25 on April 25, 2022, at 11:45 a.m. The trader makes a decision, either yes (it
will be higher) or no (it will be lower).

Let’s say the trader thinks the price will be trading above $25, on that date and
time, and is willing to bet $100 on it. If ABC shares trade above $25 at that date
and time, the trader receives a payout per the terms agreed. For example, if the
payout was 70%, the binary broker credits the trader's account with $70.

If the price trades below $25 at that date and time, the trader was wrong and
loses their $100 investment in the trade.
 ➔ Allows the user to "look back," or review, the prices
of an underlying asset over the lifespan of the option
after it has been purchased
➔ Do not have a fixed exercise price at the beginning
➔ The strike price resets to the best price of the
underlying asset as it changes
➔ The holder receives a cash settlement at execution
based on the most advantageous differential between

5. Look Back option high and low prices during the purchase period
➔ If the settlement was greater than the initial cost of
the option, then the option buyer would have profit
at settlement, otherwise loss
➔ Eliminates the risk associated with timing market
entry
➔ Typically more expensive than plain vanilla options
➔ Only available Over The Counter (OTC) and not on
any of the major exchanges
Example:
Stock closed at, Highest Price Lowest Price Fixed Lookback Floating
with net gain or Profit Lookback
loss Profit

K = $50 K = $50
$50 $60 $40 $60 - 50 = $10 $50 - 40 = $10

K = $50 K = $55
$55, +5 $60 $40 $60 - 50 = $10 $55 - 40 = $15

K = $50 K = $45
$45, -5 $60 $40 $60 - 50 = $10 $45 - 40 = $5
➔ Allows for an investor to use the option and
convert it to shares at a preset price on
specific dates before expiry
➔ Can only be exercised on predetermined
dates, often on one day each month
➔ Premiums for Bermuda options are
typically lower than those of American
options, which can be exercised any time
before expiry 6. Bermuda option
➔ The premium might be higher or lower
depending on the expiration date or the
strike price for the option
➔ The net difference of spot and strike price
is cash settled
➔ The early exercise feature doesn't
guarantee that it will be the most
advantageous time to exercise
 ➔ Allows the buyer to lock in the intrinsic value
of an option by "shouting" at the writer to do so
➔ Guarantees a minimum of profit, even if the
intrinsic value decreases after the shout
➔ More expensive than standard options

7. Shout option
➔ Path-dependent options and highly sensitive to
volatility
➔ The more volatile the underlying asset the
more likely the option holder will get the
opportunity to shout
➔ Useful for locking in gains if the buyer thinks
the option may lose its intrinsic value, or
simply to lock in profit as the option is
increasing in value
➔ Payoff depends on the average price of
the underlying asset over a certain
period of time
➔ Allow the buyer to purchase or sell the
underlying asset at the average price
instead of the spot price
➔ Typically, the average price is a 8. Asian option
geometric or arithmetic average of the
price of the underlying asset at discrete
intervals, which are also specified in the
options contract
➔ Have relatively low volatility due to the
averaging mechanism
➔ Less expensive than their standard
counterparts
Example:

For an Asian call option using arithmetic averaging and a 30-day period for
sampling the data.
On June 1st, a trader purchased a 90-day arithmetic call option on stock XYZ
with an exercise price of $22, where the averaging is based on the value of the
stock after each 30-day period. The stock price after 30, 60, and 90 days was
$21.00, $22.00, and $24.00.
The arithmetic average (mean) is (21.00 + 22.00 + 24.00) / 3 = 22.33.
The profit is the average minus the strike price 22.33 - 22 = 0.33 or $33.00 per
100 share contract.
 ➔ Type of financial derivative where the
underlying asset is a group, or basket, of
commodities, securities, or currencies
➔ Gives the holder the right, but not the
obligation, to buy or sell the basket at a specific
price, on or before a certain date
➔ Often costs less than multiple single options
because it saves on commissions and fees as it

9. Basket option involves just one transaction

➔ Basket options trade OTC
➔ Customized based on the buyer's and seller's
needs
➔ efficiently hedge risk on multiple assets at the
same time
➔ trading limits liquidity, and there is not a
guaranteed way to close the options trade ahead
of expiration
THANK YOU