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Exotic Options

What Are Exotic Options And How Do They Work?

Exotic Options - Definition

Exotic Options are non-standardized options with special conditions added so as to better serve individual investor needs and usually traded Over-The-Counter (OTC).

Exotic Options - Introduction

There are 2 broad categories of stock options in option trading; Standardized Options and Non-Standardized Options. Standardized Options, or sometimes known as "Plain-Vanilla Options", are the typical call options and put options traded over the stock exchanges. Standardized Options are the most commonly traded form of options and is what everyone is referring to when talking about call options and put options in options trading.

Non-Standardized Options are options that comes with special conditions, making them more flexible and better suited for individual investor needs.

As the additional conditions in Non-Standardized Options can be highly complex, they are not normally traded over the stock exchanges for the purpose of option trading. This kind of non-standardized options are known as Exotic Options. Exotic options are more commonly traded in the currency market than in the stock market.

Exotic options are also slowly moving out of the OTC market and into the public exchanges as they gain in standardization and popularity. Since 2008, Binary Options has been approved for listing in the US market for several stocks and indexes. As exotic options continue to gain popularity in the options trading world, it is expected that more and more exotic options will be standardized for trading in the public exchanges.

Exotic Options - Types

Here is a non-exhaustive list of well known exotic options:

Chooser Options
Exotic Options which determines if it is a call or put option only when a predetermined date is reached.

Look-back Options
The brainchild of Black-Scholes-Merton model co founder, Robert C. Merton. These are Exotic Options without a strike price. The holder of this kind of Exotic Options exercises the option at the best price achieved during the life of the option.

Shout Options
Exotic Options with 2 strike prices. One which was determined when the shout option was bought and another one determined at the discretion of the holder during the life of the shout option.

Asian Options
Exotic Options which pays off based on the average price of the underlying asset on a few specific dates.

Barrier Options
Exotic Options which comes into existence or goes out of existence when certain prices has been reached.

Binary Options
Exotic Options which pays you a fixed amount of money or the value of the underlying asset when the option expires in the money.

Power Options
Exotic Options which pays you an amount equal to the power of the value of the underlying asset above the strike price.

Basket Options
Exotic Options which is really a Plain-Vanilla option based on not one underlying asset but a group of underlying assets.

Exchange Options
Exotic Options giving the holder the right to exchange on kind of asset for another.

Extendible Options
Exotic Options which is a Plain-Vanilla option which allows the holder to extend the expiration date.

Compound Options
Exotic Options which is really an option which underlying asset is another option.

Range Options
Exotic Options which pays out based on the difference between the maximum and minimum price of the underlying asset during the life of the option.

Spread Options
Exotic Options which has the spread between 2 underlying assets as the underlying asset.

The most commonly used Exotic Options in option trading are the Look-Back Options and the Barrier Options.

Beginners to option trading should not confuse yourself to these exotic options as you will not be trading these in the exchanges.

Exotic Options - Difference Between Exotic Options & Standard Options

The table below summarizes the main differences between exotic options generally and plain vanilla options.

Exotic Options Plain Vanilla Options
Customised Standardized
OTC Traded Publicly Traded
Many Types Single Type
More Expensive Cheaper
No Standard Pricing Standardized Pricing Model

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