A:

Before learning about exotic options, you should have a fairly good understanding of regular options. Both types 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 price 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. These are also known as "average options."

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 Cboe in Chicago. 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 and dealers and are not normally standardized as they are with regular options. (See also: Options Basics.)

RELATED FAQS
  1. Is it possible to trade forex options?

    Yes. Options are available for trading in almost every type of investment that trades in a market. Most investors are familiar ... Read Answer >>
  2. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  3. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  4. Why are options very active when they are at the money?

    Stock options, whether they are put or call options, can become very active when they are at the money. In the money options ... Read Answer >>
  5. What is index option trading and how does it work?

    Learn about stock index options, including differences between single stock options and index options, and understand different ... Read Answer >>
Related Articles
  1. Trading

    Exotic Options: A Getaway From Ordinary Trading

    Exotic options are like regular options, except that they have unique features that make them complex. These unusual investment vehicles can reignite your interest in trading.
  2. Trading

    Getting acquainted with options trading

    Learn about trading stock options, including some basic options trading terminology.
  3. Trading

    Trading Options on Futures Contracts

    Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying call or put options based on the direction ...
  4. Investing

    Why Options Trading Is Not for the Faint of Heart

    Trading options is not easy and should only be done under the guidance of a professional.
  5. Trading

    How to Make Money by Trading Index Options

    Index options are less volatile and more liquid than regular options. Understand how to trade index options with this simple introduction.
  6. Trading

    Getting Started In Forex Options

    Stocks are not the only securities underlying options. Learn how to use FOREX options for profit and hedging.
  7. Trading

    Google Stock Too Expensive for You? Try Options

    Learn how to invest in Google (now Alphabet, Inc.) and other high-value stocks with less capital by using options.
RELATED TERMS
  1. Vanilla Option

    A financial instrument that gives the holder the right, but not ...
  2. Outright Option

    An outright option is an option that is bought or sold individually. ...
  3. Stock Option

    Stock options give the holder the right to buy or sell shares ...
  4. Asian Option

    An Asian option is an option type where the payoff depends on ...
  5. Average Strike Option

    An average strike option is an option type where the payoff depends ...
  6. Listed Option

    A listed option is a derivative security traded on a registered ...
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  3. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  4. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  5. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  6. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
Trading Center