Exotic option Guide, Meaning , Facts, Information and Description

In finance, an exotic option is a derivative security which has features making it more complex than commonly traded products (vanilla options). These products are usually traded over-the-counter (OTC), or are imbedded in structured notes.

Consider an equity index. A straight call or put, either american or european would be considered non-exotic (vanilla). An exotic product could have one or more of the following features:

• The payoff at maturity depends not just on the value of the underlying index at maturity, but at its value at several times during the contract's life (it could be an asian option depending on some average, a lookback option depending on the maximum or minimum, a barrier option which ceases to exist if a certain level is reached or not reached by the underlying, a digital option, range options, etc.)
• It could depend on more than one index (as in a basket options, Himalaya options or other montain range options, outperformance options, etc.)
• There could be callability and putability rights.
• It could involved foreign exchange rates in various ways, such as a quanto or composite option.

Even products traded actively in the market can have the characteristics of exotic options, such as convertible bonds, whose valuation can depend on the price and volatility of the underlying equity, the credit rating, the level and volatility of interest rates, and the correlations between these factors.

Exotic option can pose callenging problems in valuation and hedging.

See also

• Vanilla option
• Option style

External links

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