9.3.3Exotic options

There are many variations on the simple call and put options dealt with above. They

are known as exotic options. They include the following:

l

Barrier options (knock-in or knock-out) – OTC options that come into being (knock-in) or lapse (knock-out) when specied prices of the underlying product are reached. There are four types of barrier options: calls and puts, each with a knock-out or knock-in feature. A knock-in barrier option pays nothing at expiry unless it is rst brought to life as a result of the price of the underlying product reaching a specied level (the barrier). A knock-out option begins life as a standard option but is killed off if the cash price touches the barrier. Because they might never come into existence or might be killed off, they are much cheaper than conventional options. They are often used in the foreign exchange market by chartists who feel strongly that exchange rates will not fall below support levels or rise above resistance levels. Double no touch options are killed off if the cash price touches either an upper or a lower barrier.

l	Credit risk derivatives – such as the credit default option, which protects the buyer against the default of a specic company or country.

l	Lookback options – these give the right to buy (lookback call) or sell (lookback put) at the lowest price reached by the underlying product during the life of the option.

l	Asian options – options whose intrinsic value is calculated by comparing the strike price with the average spot price over the period of the option.

l	Options on options – options that give the right to buy an option.

l	Flex options – options offered by the Chicago Board Options Exchange (CBOE) that allow an institutional OTC customer to choose any strike price and expiry date up to ve years.

9.3.4

Other related products Other related products include the following:

l

Warrants – options to purchase or sell an underlying product (company shares) at a given price and time or series of prices and times. A warrant differs from a call or put option by ordinarily being issued for longer than a year. With covered warrants the shares that holders receive, if they exercise their warrants, already exist. Thus, the issuer of covered warrants is usually a bank that has bought up underlying shares. On the other hand, when companies issue warrants, usually in

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