Definition
Exotic options have payoff structures more complex than vanilla calls and puts. Common types include barrier options (activated/deactivated at price levels), Asian options (based on average prices), lookback options (based on maximum/minimum prices), and digital/binary options (fixed payout if condition met). Exotics are primarily traded OTC for customized hedging needs.
lightbulb Example
A knock-in barrier call on oil with strike $80 and barrier at $90 only becomes active if oil touches $90. If oil goes from $75 to $85, the option is worthless despite being "in-the-money" at $85 because the barrier was never hit.
verified_user Key Points
- More complex than standard calls and puts
- Barrier, Asian, lookback, digital are common types
- Primarily OTC-traded for custom hedging
- Pricing requires Monte Carlo or finite difference methods