Final Ppt Exotic
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Transcript of Final Ppt Exotic
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XOTIC OPTIONSXOTIC OPTIONS
:resented By:resented By:esented To:esented To
:ated 3ated 3 RDD .ov 2010.ov 2010
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Options
anilla Options
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Exotic Options
Exotic options are sophisticated financialinstruments that allow traders to get a rightbut not the obligations to buy or sell othersecurities.
They are called exotic because they do not fitthe standardized options that are traded onorganized exchanges like the New york StockExchange (NYSE).
Exotic options are usually bought and sold bysophisticated investors in the over-the-
counter (OTC) market.
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Types of Exotics Options
Package
NonstandardAmerican options
Forward start options Compound options
Chooser options
Barrier options
Binary options
Lookback options
Shout options
Asian options
Options to exchangeone asset foranother
Options involving
several assets
Volatility and Varianceswaps
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PACKAGES A Package is a portfolio consisting of standard
European calls, standard European puts,
forward contracts, cash, and the underlying
asset itself.
Different type of packages are:
Bull Spreads, bear spreads, butterfly spreads,
calendar spreads, straddles, strangles.
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NONSTANDARD AMERICANOPTIONS
The American options that are traded in theover-the-counter market sometimes havenonstandard features.
Early exercise may be restricted to certain
dates. The instrument is then known as aBermudan option
Early exercise may be allowed during onlypart of the life of the option. For example,
there may be an initial lock out periodwith no early exercise.
The strike price may change during the lifeof the option.
The warrants issued by corporations on theirown stock often have some or all of these
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Example
The warrants issued by corporationson their own stock often have someor all of these features.
For example: in a 7-year warrant,exercise might be possible onparticular dates during years 3 to 7,
with the strike price being $30 duringyears 3 and 4, $32 during the next 2years, and $33 during the final year.
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COMPOUND OPTIONS
Compound options are options on options.
Have two strike prices and two exercise dates.
There are four main types of compound options:
A call on a call
A put on a call
A call on a put
A put on a putFor Example, a call on a call:
On the first exercise date, T1,1, the holder of the compound option is entitled to
pay the first strike price, k1, and receive a call option. The call option gives theholder the right to buy the underlying asset for the second strike price, k2, onthe second exercise date, T2. The compound will be exercise on the firstexercise date only if the value of the option on that date is greater than thestrike price.
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ff a t E x p ira tio n
trike Price
0
Sp
ot
Pri
ce
igital CallOption Payoff at Expiration
pot
r
c
e
a
igital Puttrike Price
IGITAL OPTIONS
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DIGITAL OPTIONS
Asset or Nothing Call: S exp(-qT)N(d1)
Payoff:
= 0 if Asset Price X
Asset or Nothing Call: S exp(-qT) N(-
d1)Payoff:= 0 if Asset Price >X= Asset Price if Asset Price < X
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o n V a lu e
-nock Out Barrier
Pri
ce
of
the
Und
-ption with a Knock Out BarrierOption Value
r
ce
o
t
e
n
-ut Option with a Knock Out Ba
-nock Out Barrier
trike Pricetrike Price
, its value remains zero even if the price of the underlying shouldARRIER OPTIONS
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BARRIER OPTIONS
They are less expensive thanregular options
Classified as:Knock-out
Knock-in
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Knock-out Option
Down and out call
Ceases to exist ifthe asset price
reaches a certainbarrier level H.
Here, barrier levelis below theinitial asset price.
Down and in call
Exists only if assetprice reaches the
barrier level
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Knock-out Option
Up and out call
Ceases to exist ifthe asset price
reaches a certainbarrier level H.
Here, barrier levelis higher than thecertain assetprice.
Up and in call
Comes intoexistence only if
barrier level isreached.
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LOOKBACK OPTIONS
Payoff depend on the maximum orminimum asset price reached during
the life of the option.Floating Lookback callPayoff = Final asset price-minimum
asset priceFloating Lookback putPayoff = Maximum asset price-final
asset price
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Shout Options
A shout option is one in which the long party canshout at the short party one time during thelife of the option, which sets a sort of lowerpayoff level.
At maturity, the holder receives either theintrinsic value at the time of the shout, or thepayoff to a usual European call/put (dependingupon the type of option that it is.)
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SHOUT OPTIONS
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ASIAN OPTIONS
Average Price = Maximum (Average Spot Price Strike Price, or 0).
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HEDGING EXOTICOPTIONS In some cases exotic options are
easier to hedge than thecorresponding vanilla options(e.g., Asian options)
In other cases they are moredifficult to hedge (e.g., barrieroptions)
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STATIC OPTIONS
REPLICATION This involves approximately
replicating an exotic option with aportfolio of vanilla options
Underlying principle: if we match thevalue of an exotic option on someboundary , we have matched it atall interior points of the boundary
Static options replication can becontrasted with dynamic optionsreplication where we have to tradecontinuously to match the option
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