Exotic Options

This chapter explains how some of the more exotic options contracts can be used in speculation and hedging. Some path-dependent options have closed-form solutions for the options price, as long as one assumes that the underlying asset price is monitored continuously. Path-dependent options can often be priced using either the binomial option pricing model (BOPM) or Monte Carlo simulation (MCS). Asian options have a payoff which is based on the average price over the life of the option. An alternative and more efficient way to price an Asian option is to use MCS. Pricing path-dependent barrier options using the BOPM or MCS is straightforward in principle. Sometimes an exotic option can be priced analytically because it can be decomposed into two ‘simpler options’ that do have exact pricing formulas. Exotic options have payoffs that are more complex than those from plain vanilla European options.