19) Exotic Options

Question 1

Why might exotic options present an opportunity to make money

Answer 1

• Attract new business
• Insert clauses to our advantage

Question 2

What are some examples of exotic options

Answer 2

• Asian – exercise price based on the average share price over a given time interval
• Lookback – exercise price based on the maximum/minimum over a given time interval
• Bermudan – can be exercised on particular dates only

Question 3

What is an Asian Option

Answer 3

A contract giving the holder the right to buy or sell an underlying asset (e.g. a share) for its average price over a prescribed time interval

Question 4

What is the average of the share price S over the time interval [0, T]

Answer 4

Question 5

What is a floating strike asian option

Answer 5

Uses the share price S as the underlying asset and the average share price A(T) as the exercise price

Question 6

What is the payoff of a floating strike asian option

Answer 6

Question 7

What is the payoff of a fixed strike asian option

Answer 7

Question 8

How is the Black-Scholes model adapted to handle Asian options using the integral of the stock price

Answer 8

Question 9

How is the modified Black-Scholes equation for an Asian option derived using an adapted version of Itô’s Lemma

Answer 9