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Exotic options

In recent years substantially increased the popularity of the so-called exotic options. Unfortunately, most of them are available primarily to institutional investors and large companies. Most popular types of exotic options are the following:

Barrier - The option barrier could be presented as a condition for the exercise of the option. If this barrier is hit (one touch) or not (no touch) the option is activated (Knock In) or deactivated (Knock Out). Barrier options are cheaper than plain vanilla, because additional conditions decrease the probability that the option will be in the money at the expiry.

Depending on the effect of the barrier event on the option, we have two types of barriers:

Knock In- (KI) – when a Knock In barrier is touched by the price of the underlying asset, the option is activated and can be exercised. If the barrier event occurs, the option will remain active until expiry and can be treated as a vanilla call or put option.

Knock Out (KO) - when the Knock Out barrier is touched by the price of the underlying asset, the option is deactivated and cannot be exercised at maturity. If a barrier event occurs, the option remains deactivated until maturity and can not be exercised even the price returns back below or above the barrier.

The main types of barrier options can be found with the following names:

  • Up - and - out - this option is deactivated if the price crosses above the barrier.
  • Down - and - out - this option is deactivated if the price crosses below the barrier.
  • Up - and - in - this option is activated if the price crosses above the barrier.
  • Down - and - in - this option is activated if the price crosses below the barrier.

Basket –this option type is based on more than one underlying asset. The payout depends on the cumulative performance of all the assets included in the “basket”.

Rainbow - payout of this option is determined by the relative performance of two or more assets for the period to maturity.

Bermuda put and call - This is a combination of American and European options. It can be exercised on several predetermined dates, not just at the expiry.