Chapter 6: Exotic Options: An Illustrative Presentation

Exotic options are nonstandard financial derivatives in that characteristics like dates of maturity, payoffs, assets on which their values rely, the strike or prearranged prices, etc. make them different from standard plain vanilla options, e.g. European and American options. Various complex features of such off exchange-traded financial instruments make them more suitable for hedging and risk management. Since our chapter is illustrative, we choose three common types of exotic options, namely, Asian, barrier and binary or digital options, and analyse their properties. The style of exercise of all options is assumed to be of European type so that their prices become variants of Black–Scholes–Merton prices.