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Professional · Lesson 8 of 8Exotic options
Exotic options change the payoff rules of standard options. Barrier options switch on (knock-in) or off (knock-out) if the price touches a level. Asian options pay on the average price, reducing manipulation risk at expiry. Lookback options pay on the best price reached. Binary (digital) options pay a fixed amount or nothing.
Others include compound options (options on options), chooser options, rainbow and basket options (on several assets), quanto options (paid in another currency) and Bermudan options (exercise on set dates). Weather and catastrophe derivatives pay on temperature or disaster losses.
Exotics are mostly OTC, priced with Monte Carlo or partial differential equation methods. Retail binary options were banned in Australia by ASIC in 2021 because most clients lost money.
Key takeaways
- Barrier, Asian, lookback and binary are the main exotic families.
- Exotics are mostly OTC and priced numerically.
- ASIC banned retail binary options in 2021.
Check your understanding
1. An option that pays based on the average price over time is...
- Barrier
- Asian
- Lookback
- Binary
Show the answer
Asian. Asian options average the price.
2. A knock-out barrier call...
- Becomes active when a level is hit
- Ceases to exist if a level is hit
- Pays a fixed amount
- Is always cheaper than a share
Show the answer
Ceases to exist if a level is hit. Touching the barrier cancels it.
Go deeper
- Wikipedia: Exotic option
- YouTube videos: exotic options barrier asian binary explained
- Investopedia: exotic option
- Wikipedia: Barrier option
- Wikipedia: Asian option
- Wikipedia: Binary option
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