"Exotic" Options With Standard Exercise Styles
These options can be exercised either European style or American style; they differ from the plain vanilla option only in the calculation of their payoff value:
- A cross option (or composite option) is an option on some underlying asset in one currency with a strike denominated in another currency. For example a standard call option on IBM, which is denominated in dollars pays $MAX(S−K,0) (where S is the stock price at maturity and K is the strike). A composite stock option might pay JPYMAX(S/Q−K,0), where Q is the prevailing FX rate. The pricing of such options naturally needs to take into account FX volatility and the correlation between the exchange rate of the two currencies involved and the underlying stock price.
- A quanto option is a cross option in which the exchange rate is fixed at the outset of the trade, typically at 1. The payoff of an IBM quanto call option would then be JPYmax(S−K,0).
- An exchange option is the right to exchange one asset for another (such as a sugar future for a corporate bond).
- A basket option is an option on the weighted average of several underlyings
- A rainbow option is a basket option where the weightings depend on the final performances of the components. A common special case is an option on the worst-performing of several stocks.
- A Low Exercise Price Option (LEPO) is a European style call option with a low exercise price of $0.01.
- A Boston Option is an American option but with premium deferred until the option expiration date.
Read more about this topic: Option Style
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