Types of exotic options contracts

Exotic options are complex financial derivatives that offer features beyond the standard American and European options. They are typically used by sophisticated investors to hedge against risks or to speculate on market movements. Here are some common types of exotic options contracts:

1. Asian Options

Asian options have payoffs that depend on the average price of the underlying asset over a specified period, rather than the price at expiration. This can reduce volatility and is particularly useful in markets where price manipulation may occur.

2. Barrier Options

These options are defined by the presence of a barrier level that determines their existence. There are two main types:

• Knock-In Options: These become active when the underlying asset price reaches a certain level.

• Knock-Out Options: These become void if the underlying asset price reaches a designated barrier.

3. Binary Options

Binary options offer a fixed payout if the underlying asset meets a specific condition at expiration, typically whether the asset price ends above or below a certain strike price. The payoff is either a predetermined amount or nothing at all, making them high-risk instruments.

4. Lookback Options

These options allow the holder to "look back" over time to determine the payoff. The final payoff is based on either the maximum or minimum price of the underlying asset during the option’s life, providing an advantage to the option holder.

5. Chooser Options

Chooser options offer the buyer the ability to choose, at a certain point in time, whether the option will be a call or a put. This provides flexibility depending on market conditions when the choice is made.

6. Range Options

Also known as "corridor options," these have payoffs that depend on the price of the underlying asset falling within a specified range over the option’s life. If the price stays within the range, the option pays off; if it breaches the range, the option expires worthless.

7. Compound Options

These options allow the holder to buy another option at a specified future date. They come in two types:

• Call on a Call: The right to purchase a call option.

• Put on a Put: The right to purchase a put option.

8. Expiring Options

These options include multiple expiry dates that can be selected by the holder, allowing more strategic flexibility compared to standard options.

9. Forward Start Options

These options activate at a specified future date, allowing the buyer to lock in a strike price today for an option that will start at a future date. This is particularly useful when the investor expects favourable market developments.

Conclusion

Exotic options offer unique structures and strategies well-suited for experienced traders seeking to tailor their investments to specific market conditions. As these instruments come with increased complexity and risk, proper understanding and management are essential for effective use.