Managing reverse barrier exotic options can be a difficult proposition, especially if spot trades near the barrier as it gets close to maturity. A double-barrier option is like a more complicated version of a reverse barrier option.
Exotic Options: Barrier Options and Compound Options Definition
The payoff of average rate options is calculated by taking the difference between the average for a pre-set index over the life of the option and the strike price and then multiplying this difference by the notional amount. Because an average of a spot price is less volatile than a spot price, average rate options are naturally cheaper than the corresponding vanilla options.
A lookback call gives the owner the right to buy the underlying at expiry at a strike price equal to the lowest price that spot traded over the life of the option. A lookback put gives the owner the right to sell the underlying at expiry at a strike price equal to the highest price that spot traded over the life of the option.
The payoff of lookback options depends on the best rate that spot traded over the life of the option. Lookbacks are expensive. Anything that gives you the right to pick the top or the bottom is going to be costly. As a general rule of thumb, some people like to think that lookback prices are in the ballpark if they are roughly twice the price of an at-the-money straddle.
These types of products are often used by corporations to hedge the foreign exchange risk involved with overseas acquisitions when the success of the acquisition itself is uncertain.
Barrier Option
Sophisticated speculators use compound options to speculate on the volatility of volatility. Generally speaking, exotic options are simply more complicated and complex than vanilla options. While their uses and characteristics are more-or-less the same as most options, they also have secondary characteristics, such as callability and puttability,that can change their role in a derivatives portfolio.
This article outlines the concept of exotic options as well as their characteristics, different types, and differences from other types of options. What are Exotic Options? All provisions contained in or incorporated by reference in that agreement upon its execution will govern this Supplement except as expressly modified below. Until the parties execute and deliver that agreement, this Supplement, together with all other documents referring to the ISDA Form confirming Transactions entered into between us notwithstanding anything to the contrary in a Confirmation , shall supplement, form a part of, and be subject to, an agreement in the form of the ISDA Form as if an agreement had been executed in such form but without any Schedule, except for the following elections: i English law as the governing law, ii U.
Dollars as the Termination Currency and iii for purposes of section 6 e , loss shall apply on the Trade Date of the first such Transaction between the parties. In the event of any inconsistency between the provisions of that agreement and this Supplement, this Supplement will prevail for the purpose of this Transaction.
Exotic Options: Barrier Options and Compound Options Definition
The terms of each Transaction to which this Supplement relates are as follows:. Trade terms:. Currency Option Style:. Call Currency and Amount:.
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Put Currency and Amount:. Expiration Date and Time:. Event Period Start Time and Date:. Event Period End Time and Date:. Barrier Determination Agent:.
Additional Definitions applicable to each Transaction:. Barrier Event: means that, at any time during the Event Period, the Spot Exchange Rate in comparison to the Initial Spot Rate is equal to or beyond the Barrier Price, as determined by the Calculation Agent in accordance with the criteria for the occurrence of a barrier event set forth in the Barrier Options Disclosure and as set forth in Exhibit A hereto.
Spot Exchange Rate: means the price in the Spot Market for one or more actual foreign exchange transactions involving the Currency Pair or cross-rates constituting such Currency Pair as determined by the Calculation Agent.
Spot Market: means the global spot foreign exchange market, open continuously from a. Sydney time on a Monday in any week to p. New York time on the Friday of that week. Additional copies of this document are available on request. Additional Terms applicable to each Transaction.
Notification of event: The Calculation Agent shall promptly notify the other Party or Parties if the Calculation Agent is not a Party of the occurrence of an event relating to the Transaction. A failure to give such notice shall not prejudice or invalidate the occurrence or effect of an event. Settlement: Unless otherwise agreed, a Transaction, if exercised, shall be settled on its Settlement Date by the payment by each Party to the other as set forth in Exhibit A hereto. Exchange of Transaction Details Confirmation:. Account Details. Account for payments to Party A:. Account for payments to Party B:.
Broker Details:. Account Details:. Contact Confirmation Control telephone: with any questions regarding this Confirmation. This supplement shall be effective as of February 11, Senior Executive Vice President.
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Knock In Option Barrier Event Barrier Price B. Automatic Replacement by Forward Contract:. Barrier Price:. Business Day Convention Applicable to Settlement:. Lock In Strike Price A:. Copying and distributing are prohibited without permission of the publisher. The aim of this Learning Curve is to explain the behaviour of a particularly interesting kind of barrier option, the Parisian, and to focus on its use in structuring exotic equity derivatives products.
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Parisian barrier options were developed by a group of Paris-based academics as an extension to classical barrier options. The difference between a Parisian and a classical barrier lies in the way the barrier level is triggered. In the case of the Parisian, the closing price of the underlying assets must remain for a predefined number of trading days, the 'window,' above or below the assigned price level before the payoff disappears or comes into place.
If the counting of the window's days resets every time the barrier is crossed, it is a standard Parisian option; if the counting is never reset from the first crossing, it is a cumulative Parisian option.
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Parisian barriers lower the risk of the product. The use of a Parisian in structuring a reverse convertible with a down-and-in feature avoids the problem of 'exogenous hits,' which have caused many problems for retail investors and regulators in some European countries in the recent past. With a Parisian barrier the price decline should have the characteristic of a short negative trend, lasting for a certain spell of time, not an abnormal downward price movement.
Parisian barriers reduce the possibility of manipulating the underlying.