final ppt exotic

8/6/2019 Final Ppt Exotic

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XOTIC OPTIONSXOTIC OPTIONS

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Options

anilla Options


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Exotic Options

Exotic options are sophisticated financialinstruments that allow traders to get a rightbut not the obligations to buy or sell othersecurities.

They are called exotic because they do not fitthe standardized options that are traded onorganized exchanges like the New york StockExchange (NYSE).

Exotic options are usually bought and sold bysophisticated investors in the over-the-

counter (OTC) market.


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Types of Exotics Options

Package

NonstandardAmerican options

Forward start options Compound options

Chooser options

Barrier options

Binary options

Lookback options

Shout options

Asian options

Options to exchangeone asset foranother

Options involving

several assets

Volatility and Varianceswaps


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PACKAGES A Package is a portfolio consisting of standard

European calls, standard European puts,

forward contracts, cash, and the underlying

asset itself.

Different type of packages are:

Bull Spreads, bear spreads, butterfly spreads,

calendar spreads, straddles, strangles.


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NONSTANDARD AMERICANOPTIONS

The American options that are traded in theover-the-counter market sometimes havenonstandard features.

Early exercise may be restricted to certain

dates. The instrument is then known as aBermudan option

Early exercise may be allowed during onlypart of the life of the option. For example,

there may be an initial lock out periodwith no early exercise.

The strike price may change during the lifeof the option.

The warrants issued by corporations on theirown stock often have some or all of these


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Example

The warrants issued by corporationson their own stock often have someor all of these features.

For example: in a 7-year warrant,exercise might be possible onparticular dates during years 3 to 7,

with the strike price being $30 duringyears 3 and 4, $32 during the next 2years, and $33 during the final year.


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COMPOUND OPTIONS

Compound options are options on options.

Have two strike prices and two exercise dates.

There are four main types of compound options:

A call on a call

A put on a call

A call on a put

A put on a putFor Example, a call on a call:

On the first exercise date, T1,1, the holder of the compound option is entitled to

pay the first strike price, k1, and receive a call option. The call option gives theholder the right to buy the underlying asset for the second strike price, k2, onthe second exercise date, T2. The compound will be exercise on the firstexercise date only if the value of the option on that date is greater than thestrike price.


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igital CallOption Payoff at Expiration

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IGITAL OPTIONS


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DIGITAL OPTIONS

Asset or Nothing Call: S exp(-qT)N(d1)

Payoff:

= 0 if Asset Price X

Asset or Nothing Call: S exp(-qT) N(-

d1)Payoff:= 0 if Asset Price >X= Asset Price if Asset Price < X


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o n V a lu e

-nock Out Barrier

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Und

-ption with a Knock Out BarrierOption Value

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-ut Option with a Knock Out Ba

-nock Out Barrier

trike Pricetrike Price

, its value remains zero even if the price of the underlying shouldARRIER OPTIONS


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BARRIER OPTIONS

They are less expensive thanregular options

Classified as:Knock-out

Knock-in


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Knock-out Option

Down and out call

Ceases to exist ifthe asset price

reaches a certainbarrier level H.

Here, barrier levelis below theinitial asset price.

Down and in call

Exists only if assetprice reaches the

barrier level


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Knock-out Option

Up and out call

Ceases to exist ifthe asset price

reaches a certainbarrier level H.

Here, barrier levelis higher than thecertain assetprice.

Up and in call

Comes intoexistence only if

barrier level isreached.


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LOOKBACK OPTIONS

Payoff depend on the maximum orminimum asset price reached during

the life of the option.Floating Lookback callPayoff = Final asset price-minimum

asset priceFloating Lookback putPayoff = Maximum asset price-final

asset price


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Shout Options

A shout option is one in which the long party canshout at the short party one time during thelife of the option, which sets a sort of lowerpayoff level.

At maturity, the holder receives either theintrinsic value at the time of the shout, or thepayoff to a usual European call/put (dependingupon the type of option that it is.)


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SHOUT OPTIONS


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ASIAN OPTIONS

Average Price = Maximum (Average Spot Price Strike Price, or 0).


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HEDGING EXOTICOPTIONS In some cases exotic options are

easier to hedge than thecorresponding vanilla options(e.g., Asian options)

In other cases they are moredifficult to hedge (e.g., barrieroptions)


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STATIC OPTIONS

REPLICATION This involves approximately

replicating an exotic option with aportfolio of vanilla options

Underlying principle: if we match thevalue of an exotic option on someboundary , we have matched it atall interior points of the boundary

Static options replication can becontrasted with dynamic optionsreplication where we have to tradecontinuously to match the option


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final ppt exotic

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