Hull : Exotic options
12 important questions on Hull : Exotic options
Four factors that drive the development of exotic products
- Hedging need
- Tax, accounting, legal or regulatory motive
- To reflect a view on market variables; eg volatility
- To make a new product to sell
What is a "forward start option"
Options that start in the future; close contract now for an option that starts at t+1.
Value of a forward start option=c*e(-qT)
Where q is the dividend yield and c is the value of a regular ATM option with a life of (t2-t1)
What is a "compound option"
Options on options: they have two strike prices and two exercise dates.
There are four types:
- call on call
- call on put
- put on call
- put on put
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What is a "chooser option" and to what hedging strategy does it compare?
Option where the holder has the right to decide whether it is a call or a put option.
Value is MAX(c,p)
It compares to a straddle (long call and long put), used when you expect much volatility.
Chooser is cheaper; you have less flexibility after you made your decission
What is a "binary option" and to what hedging strategy does it compare?
Options with discontinuous payoffs:
- Cash-or-nothing: if in the money it pays a fixed amount or nothing
- Asset-or-nothing: pays asset or nothing
It compares to a bull spread (long call plus short call with higher strike price) when the pay off is larger than the maximum price.
Regular European Call = long in asset-or-nothing call // short in an-cash-or-nothing call.
Regular European Put = short in asset-or-nothing put // long in cash=or-nothing put.
What is a "lookback option"
Floating lookback call = final - minimal
Floating lookback put = max - final
Fixed lookback call = max - strike
Fixed lookback put = strike - min
What is a "shout option"?
A regular option contact plus the possibility for the holder to use a "shout", so he can fix the minimum payoff.
What is an "asian option"?
A regular option in which the payoff depends on the average price during (part of) the life of the option.
Average price call/put: max of fixed strike price & average stock price
Average strike call/put: ????
Relatively easy to hedge, becuase payoff becomes progressively more certain as we approach maturity.
What is an "exchange option"?
Option to pay with an asset worth of U(T) in order to receive (to exchange) asset worth of V(T)
What is a "raibow option"?
Options with at least two different (risky) assets
What is a "basket option"?
Option in which payoff depends on the value of a basket of assets (stocks, stock indices, currencies)
What is a "volatility/variance swap"?
Volatility swap: agreement to exchange realized volatiltiy of an asset for a pre-specified volatility
Varience swap: agreement to exchange realized variance rate of an asset for a pre-specified varience
Varience swap is easier to value, because it can be replaced using a portfolio of puts and calls.
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