Before learning about exotic options, you should have a fairly good understanding of regular options. Both types of options share the idea of having the right to buy or sell an asset in the future, but the way investors realize profits using these options can differ dramatically.

Simply put, an exotic option is any type of option other than the standard calls and puts found on major exchanges. An investor who buys a call option has essentially bought a standardized right to purchase a specific amount of an underlying asset at the agreed upon strike price, while a put option gives the investor the right to sell the specific asset at the strike if the price of the underlying decreases. These regular options are also known as plain vanilla options. Exotic options can be quite different, as these examples show:

Chooser option
: An option that gives the investor the right to choose whether the option is a put or a call at a certain point during the option's life. Unlike regular options that are purchased as a call or a put at inception, these exotic options can change during the life of the option.

Barrier option
: A type of option whose payoff depends on whether or not the underlying asset has reached or exceeded a predetermined price. The right to purchase the underlying at an agreed strike price only kicks in when the price hits the agreed upon 'barrier'. This is unlike a regular option because the holder of a vanilla option can buy the underlying at the strike price at any time after inception.

Asian option: Anyone who invests in regular options will attest to their volatility. Asian options are a good way to reduce this volatility. These exotic options have a payoff that depends on the average price of the underlying asset over a certain period of time as opposed to at maturity. Also known as an average option.

The final difference between exotic options and regular options has to do with how they trade. Regular options consist of calls and puts and can be found on major exchanges such as the Chicago Board Options Exchange. Exotic options are mainly traded over the counter, which means they are not listed on a formal exchange, and the terms of the options are generally negotiated by brokers/dealers and are not normally standardized as they are with regular options.

For further reading, see our Options Basics tutorial.

  1. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  4. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  5. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  6. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Calculating Valuation

    Valuation is the process of determining what an asset is worth.
  2. Investing

    Binary Options For Capital-Protected Investments

    Binary options may sound complex, but they can be used to create capital-protected investments. Here's how.
  3. Chart Advisor

    Stocks at Important Technical Levels

    These stocks are breaking or holding at key support and resistance levels. How they react here impacts the direction of the price over the coming months.
  4. Technical Indicators

    Explaining Autocorrelation

    Autocorrelation is the measure of an internal correlation with a given time series.
  5. Chart Advisor

    ChartAdvisor for October 9 2015

    Weekly technical summary of the major U.S. indexes.
  6. Chart Advisor

    These Oil & Gas Stocks Have Reversed

    It's been a long downtrend for oil stock owners, but there's hope. These four oil and gas stocks have reversed and may keep trending to the upside.
  7. Chart Advisor

    4 European Stocks to Consider Buying

    European companies, listed on US exchanges, that are providing buying opportunities right now.
  8. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  9. Chart Advisor

    ChartAdvisor for October 2 2015

    Weekly technical summary of the major U.S. indexes.
  10. Investing

    How Diversifying Can Help You Manage Market Mayhem

    The recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
  1. Put-Call Parity

    A principle that defines the relationship between the price of ...
  2. Maturity

    The period of time for which a financial instrument remains outstanding. ...
  3. Employee Stock Option - ESO

    A stock option granted to specified employees of a company. ESOs ...
  4. Implied Volatility - IV

    The estimated volatility of a security's price.
  5. Plain Vanilla

    The most basic or standard version of a financial instrument, ...
  6. Normal Profit

    An economic condition occurring when the difference between a ...

You May Also Like

Hot Definitions
  1. Ex Works (EXW)

    An international trade term requiring the seller to make goods ready for pickup at his or her own place of business. All ...
  2. Letter of Intent - LOI

    A document outlining the terms of an agreement before it is finalized. LOIs are usually not legally binding in their entirety. ...
  3. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  4. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  5. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  6. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!