Exotic Options

Digital and Chooser Options

Digital options, sometimes called binary options, are of two types:
Asset-or-nothing options pay the holder the asset if the option expires in the money and nothing otherwise. Cash-or-nothing options pay the holder a fixed amount of cash (usually $1) if the option expires in the money and nothing otherwise.

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Path-Dependent Options
Path-dependent options are options in which the payoff is determined by the sequence of prices followed by the asset and not just by the price of the asset at expiration.

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Path-Dependent Options (continued)
Asian option: an option in which the final payoff is determined by the average price of the asset during the options life. Some are average price options because the average price substitutes for the asset price at expiration. Others are average strike options because the average price substitutes for the exercise price at expiration. Can be calls or puts. Useful for hedging or speculating when the average is acceptable as a measure of the underlying risk. Also useful for cases where market can be manipulated.

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Path-Dependent Options (continued)
Lookback option: Also called a no-regrets option, it permits purchase of the asset at its lowest price during the options life or sale of the asset at its highest price during the options life.

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Path-Dependent Options (continued)
Barrier Options: Options that either terminate early if the asset price hits a certain level, called the barrier, or activate only if the asset price hits the barrier.
The former are called knock-out options (or simply out-options) and the latter are called knock-in options (or simply in-options). If the barrier is above the current price, it is called an up-option. If the barrier is below the current price, it is called a down-option.

 Barrier options are normally cheaper than ordinary options because they provide payoffs for fewer outcomes than ordinary options.

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Other Exotic Options:
compound and installment options
Option on options. Call on call, call on put etc.,

exchange options
Option to exchange one asset for another.

rainbow options
Options involving two or more risky assets. Ex- basket option where payoff depends on the value of portfolio of assets.

Forward Start Option

Paid for now, with the option becoming effective at a future date

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Bermudan Options
Non standard American option in which early exercise is restricted to certain dates during the life of the option. Exercise price is always the same

As-You-Like-It Option
The owner can decide whether it is a put or a call by a certain date