Editing Exotic option

{{Short description|Derivative which has features making it more complex than commonly traded products}}
In [[finance]], an '''exotic option''' is an [[Option (finance)|option]] which has features making it more complex than commonly traded [[vanilla option]]s.  Like the more general [[exotic derivatives]] they may have several triggers relating to determination of payoff.  An exotic option may also include a non-standard underlying instrument, developed for a particular client or for a particular market.  Exotic options are more complex than options that trade on an [[Exchange (organized market)|exchange]], and are generally traded [[Over-the-counter (finance)|over the counter]].

==Etymology==
The term "exotic option" was popularized by [[Mark Rubinstein]]'s 1990 working paper (published 1992, with Eric Reiner) "Exotic Options", with the term based either on [[2010 Kentucky Derby#Exotic wager|exotic wagers]] in [[horse racing]], or due to the use of international terms such as "[[Asian option]]", suggesting the "exotic Orient".<ref name="Palmer14jul2010" /><ref>{{cite journal |last1=Rubinstein |first1=Mark|last2=Reiner|first2=Eric|title=Exotic Options|journal=Research Program in Finance Working Papers |publisher=Working Paper, University of California at Berkeley |year=1995|url=http://ideas.repec.org/p/ucb/calbrf/rpf-220.html}}</ref>

Journalist Brian Palmer used the "successful $1 bet on the [[superfecta]]" in the 2010 Kentucky Derby that "paid a whopping $101,284.60" as an example of the controversial high-risk, high-payout exotic bets that were observed by track-watchers since the 1970s in his article about why we use the term exotic for certain types of financial instrument. Palmer compared these horse racing bets to the controversial emerging exotic financial instruments that concerned then-chairman of the [[Federal Reserve System|Federal Reserve]] [[Paul Volcker]] in 1980. He argued that just as the exotic wagers survived the media controversy so will the exotic options.<ref name="Palmer14jul2010">{{cite web |title=Why Do We Call Financial Instruments "Exotic"? Because some of them are from Japan |author=Brian Palmer |date=14 July 2010 |publisher=Slate |url=http://www.slate.com/articles/news_and_politics/explainer/2010/07/why_do_we_call_financial_instruments_exotic.html |access-date=9 September 2013 |quote=The article quotes then-chairman of the Federal Reserve Paul Volcker in 1980 when he argued, "This is hardly the time to search out for new exotic lending areas or to finance speculative or purely financial activities that have little to do with the performance of the American economy."}}</ref>

In 1987, Bankers Trust's Mark Standish and David Spaughton were in Tokyo on business when "they developed the first commercially used pricing formula for options linked to the average price of crude oil." They called this exotic option the Asian option, because they were in Asia.<ref name="Falloon1999">{{cite book|editor=William Falloon|editor2=David Turner|year=1999|chapter=The evolution of a market|title=Managing Energy Price Risk|location=London|publisher=Risk Books}}</ref>

== Development ==

Exotic options are often created by [[financial engineer]]s and rely on complex models to attempt to price them.

==Features==
A straight [[call option|call]] or [[put option]], either [[Option style|American]] or European, would be considered a non-exotic or vanilla option. There are two general types of exotic options: path-independent and path-dependent. An option is path-independent if its value depends only on the final price of the underlying instrument. Path-dependent options depend not only on the final price of the underlying instrument, but also on all the prices leading to the final price. An exotic option could have one or more of the following features:
* The payoff at maturity depends not just on the value of the underlying instrument at maturity, but also on its value at several times during the contract's life (for example 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]], peroni options, range options, [[spread option]]s, etc.)
* It could depend on more than one index, such as in [[basket option]]s, outperformance options, Himalaya options, or other mountain range options.
* The manner of settlement may vary depending on the [[moneyness]] of the option at expiry, such as a cash or share option.
* There could be callability and putability rights.
* It could involve foreign exchange rates in various ways, such as a [[quanto]] or composite option.

Even products traded actively in the market can have some exotic characteristics, such as [[convertible bond]]s, whose valuation can depend on the price and [[Volatility (finance)|volatility]] of the underlying [[Stock|equity]], the issuer's [[credit rating]], the level and volatility of [[interest rate]]s, and the [[correlation]]s between these factors.

==Barriers==

[[Barrier option|Barriers]] in exotic option are determined by the underlying price and ability of the stock to be active or inactive during the trade period, for instance up-and-out option has a high chance of being inactive should the underlying price go beyond the marked barrier. Down-and-in-option is very likely to be active should the underlying [[price]]s of the stock go below the marked barrier. Up-and-in option is very likely to be active should the underlying price go beyond the marked barrier.<ref>{{cite web |url=http://www.binaryoptionsblacklist.com/exotic-and-double-digital-options/ |title=Exotic And Double Digital Options |date=May 18, 2013 |publisher=BOB |access-date=11 July 2013 |archive-date=4 March 2014 |archive-url=https://web.archive.org/web/20140304125311/http://www.binaryoptionsblacklist.com/exotic-and-double-digital-options/ |url-status=dead }}</ref>
One-touch double barrier binary options are path-dependent options in which the existence and payment of the options depend on the movement of the underlying price through their option life.<ref>{{cite web |url=http://binarytoday.com/double-barrier-and-exotic-options/ |title=Double Barrier And Exotic Options |date=March 9, 2015 |publisher=BinaryToday |access-date=April 15, 2015}}</ref>

== Examples ==
{{colbegin}}
*[[Barrier option|Barrier]]
*Cash or Share
*[[Cliquet]]
*[[Compound option]]
*[[Constant proportion portfolio insurance]]
*Digital/[[Binary option]]
*[[Lookback option|Lookback]]
*[[Rainbow option]]
*[[Timer call]]
*[[Variance swap]]
*[[Option style#Non-vanilla exercise rights|Bermudan options]]
{{colend}}

== References ==
{{Reflist}}

== Further reading ==
*{{cite book | author=Haug, Espen Gaarder | title=The Complete Guide to Option Pricing Formulas | publisher=[[McGraw-Hill]] | location=New York | year=2007 | isbn=978-0-07-147734-5}}
*{{cite book | last=Banks | first=Erik |author2=Paul Siegel | title=The Options Applications Handbook: Hedging and Speculating Techniques for Professional Investors | publisher=Wiley | location=New York | year=2007 | isbn=978-0-07-145315-8}}
*{{cite book | last=Kuznetsov | first=Alex | title=The Complete Guide to Capital Markets for Quantitative Professionals | publisher=McGraw-Hill | location=New York | year=2006 | isbn=0-07-146829-3}}
*{{cite book | last=Kyprianou | first=Andreas E. |author2=Wim Schoutens|author3=Paul Wilmott | title=Exotic Option Pricing and Advanced Levy Models | publisher=[[John Wiley & Sons]] | location=Hoboken, NJ | year=2005 | isbn=0-470-01684-1}}
*{{cite book | author=Rebonato, Riccardo | author-link=Riccardo Rebonato | title=Interest-rate Option Models: Understanding, Analysing and Using Models for Exotic Interest-rate Options | publisher=[[McGraw-Hill]] | location=New York | year=1998 | isbn=0-471-97958-9}}

{{Derivatives market}}
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[[Category:Mathematical finance]]
[[Category:Options (finance)]]