Other Options
• Exotic Derivatives
• A complex financial instrument which is tailored to meet the specifications of a particular
counterparty.
• Exotic derivatives are classes of option contracts with structure and features different from Plain
Vanilla options.
• Hybrid form of American and European style of options.
• Traded on OTC market.
• More complex and vary in terms of Payoff structure.
• Plain vanilla derivatives (forward, futures, options, Swap) represent the most basic version of
financial derivatives which includes the initial cost, current market value, expiration date, amounts
to be paid and the cost of the existing position.
• Basic Types
• Barrier Options
• The contract fixes a specified level of the underlying price called barrier.
• The option pay-off is conditional on the underlying price process hitting the barrier.
• The option comes into life and can be exercised only if the underlying price touches the barrier within expiration.
• Example: Call option has a strike price of $ 100 and a barrier of $ 110 while the underlying security trades at $ 90. The option
is not exercisable until the underlying asset price climbs above the $ 110 barrier. The option holder pays a premium but that
premium is lower than for a regular call.
• Chooser Options
• The holder is allowed to decide whether it is a call or a put prior to the expiration date.
• The choice between the two depends largely part on the value of each.
• Example: The strike price for a stock is $100, while the expiration date is six months from now. If market price of the stock is
$120 just before the expiration date, then change it into a call to purchase stocks at a lower rate. When the market price is more
than the strike price, change it into a put option.
• Compound option
• Also called “Split fee” or “option on option”
• Right or choice not an obligation to buy another option at specific price on the expiry of first maturity date. Underlying is an option.
• Example of European style call on a call. First Option: Strike Price is $1.05 per EUR with 1 month expiry and premium $0.01 per
EUR. Second Option (EUR/USD Call Option): Strike Price is $1.08 per EUR with expiry 3 months and premium $0.02 per EUR (if
first option is exercised). At expiry, if EUR/USD Rises above $1.05 after 1 Month, exercise First Option. If EUR/USD rises above
$1.08 at expiry, the second option is exercised.
• Look back Option
• Allows the holder to exercise an option at the most beneficial price of the underlying asset over the life of the option.
• This is basically choosing when to enter a position and when to exit it, to make the largest possible returns.
• Example: In case the highest price of the underlying asset during the option period is $ 200, while the lowest price is $ 100. And the
strike price is $ 150. Then, the best price is $ 200 and the profit (excluding cost) for the holder would be $ 50 i.e. $ 200 – $150.
• Asian Option
• Payoff is determined by an average price of the underlying asset over a specified period rather than the price just at the maturity
date.
• Example: A call option strike price is $450. The average is based on the underlying value after every 30 days. If stock price after 30
days was $ 540, after 60 days $ 630, after 90 days $ 720. The arithmetic mean = (540 + 630 + 720) / 3 = $630, Profit will be 630 -
450 = $ 180 (excluding cost).
• Bermuda Option
• Exercised earlier but only on specific dates before it expires.
• Example: a six-month American call could be exercisable only on the last day of each month.
• Binary Option
• Also called Digital Option
• Guarantees the payoff based on the happening of a specific event.
• Example: Binary option has a payoff of $ 40,000 for an asset price above $10. The payoff will be $0 if the asset price at maturity is
$ 9.99 and $ 40,000 if the asset price is $ 10.01. Whether asset price goes higher or lower, the outcomes are fixed at 40,000 profit.
• Basket Option
• Underlying depends on the value of the portfolio.
• Gives the right but not the obligation to buy or sell a basket of securities. The components of the basket could be bonds,
stocks, currencies, etc.
• Example: A trader has a basket of commodity currencies made up of 35% Swiss Franc, 35% Canadian Dollar, 20% New
Zealand Dollar and 10% Australian Dollar. All of these currencies can be traded in a single transaction, paid for in only
the investor’s home currency using Binary option
• Spread Option
• Payoff is based on the difference (spread) between two underlying asset prices.
• Example: Consider 1 month Strike Price $20 per barrel (underlying asset gasoline price minus crude oil price) with
premium $3 per barrel. If at expiry, Gasoline Price is $90 per barrel and Crude Oil Price is $65 per barrel. Then, the
Spread is $25 per barrel (greater than $20 strike price) and Payoff will be $25 - $20 = $5 per barrel having Net Profit $2
per barrel i.e. $5 - $3 (premium). If the spread is expected to widen, a Call option is chosen otherwise a Put option.
