Chapter 17 - Exotic options Flashcards
loosely define exotic options
regular option, but with some differences in contract specifications. for instance, intrinsic value can be based on average asset price rather than asset price at expiration.
define asian option
payoff is based on average price over some period of time
are asian options path dependent?
Yes
when might we consider asian options
whenever the relience on one point in time is idiotic. some stocks may have low liquidity and subject to unusual patterns etc
whats worth more at issuance: regular or asian?
asian are less expensive. this is because the average price is less volatile than the stock price itself. lower volatility measn lower price
how many variants of asian options are there?
3 binary deicisns:
1) arithemtic or geometric average
2) put or call
3) is average asset price used in place for the underlying asset or the strike price
difference between arithmetic and geometric average+
arithmetic sums the values, and divides on number of values
geoemtric multiply values, and then take n’th root.
what is an “average strike option”?
the average is used for the strike price.
call = max (asset at exp - average asset value, 0)
what is the other option than “average strike option”?
Average price option
what is a compound option
an option to buy an option
elaborate on compound options
two strikes ,two expirations.
we only exercise a compound option if the stock price is so high that the value of the call option exceeds the strike price we have to pay on the compound option.
max [C(s, k, T-t) - x, 0]
x is the strike price of the compound option. k is the strike price of the regular option.
THe value of the call option C must be larger than x.
we can also add that this all means that there will be a certain stock price S_x that makes the entier shit profitable.
elaborate on the events that must occur in order for compound option to be profitable
There are 2 events.
1) At expiration of the compound, the stock price must be larger than the threshold price.
2) At time T (expiration of underlying option) the stock price at that point in time must be larger than the strike price of that option.
So, just because we exercise the compound option doesnt mean that the entire position is profitable. Both events must occur.
what can we say about valuing compound options?
It is conceptually the same as regular options, but there is mathematical differences. This is because of how the ordinary options use log normal distribution in BS. For the case of an option on an option, we cannot use a log normal distribution, so the entire thing becomes fucked. With an option on an option, we would need ot model option prices as log normal, which they simply are not as there are thresholds under which they simply are worthless.
what is the put call parity relationship for compound options?
