Flashcards
Ch 25: Exotic Options
Cards in this deck (10)
- 1Exotic option- Non-standard option traded in OTC markets
- Payoff or exercise features differ from standard options
- Advantage: more targeted payoff => can address a specific hedging need - 2Types of exotics- Path-independent - payoff at time of exercise does not depend on historical path e.g. forward starts, binaries, compounds
- Path-dependent e.g. barriers, Asian - 3Forward start option- Come to life at a future time, T1 , with maturity at T2 > T1
- Strike price at T1 is K = αST1
- ATM forward start option => α = 1
- E.g. employee stock options - 4Binary options- Options with discontinuous payoffs
- Advantage: simple bet => no concern about how much ST > K, as long as ST > K
- Cash-or-nothing call: pays Q if ST > K, otherwise pays nothing
- Asset-or-nothing call: pays ST if ST > K, otherwise pays nothing - 5Binary options: pricing and payoffsc = long asset-or-nothing call + short cash-or-nothing call (where cash payoff = K)
p = long cash-or-nothing put (where cash payoff = K) + short asset-or-nothing put - 6Compound options- Option to buy or sell an option
- 2 strike prices and 2 exercise dates
- Priced using bivariate normal distribution or binomial tree - 7Compounds options: call on call- On T1, holder has the right to buy a call option for K1
- On T2, holder has the right to buy the underlying for K2
- Option 1 can be exercised on T1 only if value of option 2 on that date exceeds K1 - 8Barrier options- Payoff depends on whether the underlying's price reaches a barrier price (H) before a certain date (T)
- Advantage: more targeted bet than vanilla options, so cheaper
- Classification: knock-in/out and up/down - 9Barrier options: pricing1. Binomial tree
2. Monte Carlo simulation
3. Risk-neutral valuation e.g. up-and-in call
- 10Asian options- Payoff depends on some average price (Save) of the underlying
- Advantage: hedges exposure to the average; volatility of average < volatility of price itself => cheaper
- Pricing: no exact analytical valuation; can be approximately valued assuming average stock price is lognormally distributed or using Monte Carlo simulation
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- Business/Economics (BFC3340: Derivatives 2) Flashcards on Ch 25: Exotic Options, created by Melina Mackey on 12/10/2019.
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- Melina Mackey
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- Created by Melina Mackey · Oct 4, 2019
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