by chris dibella exotic options. options a financial derivative that represents a contract sold by...
TRANSCRIPT
BY CHRIS DIBELLA
Exotic Options
Options
A financial derivative that represents a contract sold by one party to another.
This contract offers the buyer the right to buy or sell a security at an agreed upon price during a certain period of time.
Two types: Vanilla and Exotic
Exotic Options
Term was popularized by Mark Rubinstein in 1990 Based on either exotic wagers in horse racing or from
the use of exotic terms when naming options
Options with more complex features than vanilla options
Usually traded over the counter Directly between two parties Option can be tailored to fit any situation
Path Dependence vs. Independence
Dependent Value of the option depends on the path the
underlying takes
Independent Value depends only on the value of the underlying
when exercised or expired
Pricing Methods
Expected payoff pricingBlack-Scholes MethodBinomial TreesMonte Carlo Methods
Generate many random walks
Average option values anddiscount to current prices
dxdtS
ds
Asian Options
Introduced in Tokyo, Japan in 1987
Payoff is determined by the average underlying price over a pre-set period of time
Two Types: Fixed Strike
Payoff is the difference between a set strike price and the average value of the underlying
Floating Strike Payoff is the difference between the underlying value at
expiration and the average underlying value
Examples
Fixed Strike Floating Strike
Why buy an Asian Option
Want to cover many transactions using only one hedging instrument
Reduce the dependence of an option on the spot price of the underlying on a single date
Less expensive since the volatility of the average price is usually less than the volatility of the spot price
Binary Options
aka digital options or all-or-nothing options
Can be calls or puts, American or European
Payoff is either a fixed amount or nothing
Two Types Cash-or-nothing
Pays fixed amount if the underlying is in the money Asset-or nothing
Pays the value of the underlying
Pricing
Cash or Nothing Payoff is a constant
Asset or Nothing Payoff is the value of the underlying, ST
K
rT dscSpdfe )()(
K
rT dsSSpdfe )()(
Barrier Options
Similar to vanilla options – can be calls or puts, American or European
Becomes active or inactive after the underlying crosses a certain point Knock-In Options-Option becomes active only if the
underlying crosses the barrier Knock-Out Options-Option becomes void if the underlying
crosses the barrier
Once the underlying passes the barrier it does not matter if it passes it again
Example
Call Option Comparison
You are looking to buy a call option on a stock with the following information: S0=100, K=100, r=.003, σ=.3, T=1.5
Vanilla Call Value - $14.77
What do you expect the value of the same call with a Knock-Out barrier, B=150, to be?
As the barrier moves closer the strike price, what do you think will happen to the value of the option?
Barrier Price
Knock-Out Barrier
150 140 130 120 110 100
Option Price
3.51 2.04 .91 .25 .02 0
Why buy a Barrier Option?
Cheaper than a plain call or put Creates opportunity for greater profits
Expect movement within a limited range
Disadvantages Knock-Out
Too much movement could void an option Knock-In
Option can be out of the money even when it has passed the strike price
Lookback Options
Created in 1979 by Robert C. MertonCalls or PutsAllows holder to “lookback” for the optimal
valuesTwo Types:
Fixed Strike Payout is difference between strike price and the
maximum or minimum value of the underlying Floating Strike
Payout is difference between underlying value at expiration and the maximum or minimum value of the underlying
Example
Call Option Comparison
You are looking to buy a call option on a stock, with the following information: S0=100, K=100, r=.003, σ=.3, T=1.5
Vanilla Call Value - $14.77Knock-Out Call Value - $3.51
What do you expect the value of the same call with a fixed strike lookback?
Why buy a Lookback Option
Eliminates any timing problems
Maximizes payoff
Disadvantages Expensive
Other Exotic Options
Chooser Option Allows holder to choose whether it is a call or put at a
particular dateRainbow Option
Option linked to two or more underlying valuesShout Options
Option that allows holder to adjust aspects of the option at certain intervals, such as the strike price or time to maturity
Sources
http://www.riskglossary.com/ http://en.wikipedia.org http://www3.sitmo.com
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