Exotic Options
There are many types of options in the modern markets; some more exotic than others. It is important to differentiate regular from binary options and even from the other types of exotic options, like Bermuda, quanto options etc. Since binary options have been explored in the past, we will shed some light on other types of exotic options.
Other exotic options
Bermuda options are different from the mainstream variety by allowing the possibility of several possible exercise dates. They are a compromise between writers seeking more control over the options they issue and buyers looking for lesser premiums.
Quantity-adjusted options (quantos) are a type of options which offer a fixed exchange rate in a currency of your choice. They make an excellent choice for investors doing business in foreign countries who also want to lock in the exchange rate so their profit margin remains stable. This way, holders get a fixed exchange rate, and writers get a bigger premium.
There are other types of exotic options, such as choosers (you get to decide whether your option is call or put during its time window), barrier options, Asian options etc. Individual types of exotic options are a topic for further discussion.
Similarities with mainstream options
While all exotic options differ from mainstream options in some regard, they are still options. The underlying financial instruments are the same, they share many of their basic elements and generally follow the same rules. Exotic options are considered “over the counter” financial products and as a result, the regulation can be a bit scarce.
Differences from mainstream options
A unique and defining feature of binary options, which sets them apart even from other exotic options, is their fixed return. Like with any other option, you aim for a certain target price, and upon achieving it, you have the reason to start celebrating. However, with any option apart from binaries, you have more reasons to celebrate as time goes by and the trend progresses beyond your expectations; this means your profits would keep increasing. However, with binary options, your profits remain capped no matter how much your expectations got exceeded – something that can drive you mad if you let it get to you. But then again, if your expectations fail miserably, binary options tend to limit your losses to the premium you paid upon acquiring them, and since they do not refer to the actual financial products, this need not bother you that much. Of course, other options allow for the possibility of letting them expire as they do not require you to activate them, unless you want to. Liquidity and pricing plague exotic options more than any other type. Because of their “over the counter” status, regulation is lax, so there is plenty of room for abuse. And accurate pricing is also an issue, as there is no reliable and objective way of pricing every single one of them. Both of these issues have been addressed by regular options – somewhat.