Lecture 7 Flashcards
What distinguishes exotic options from standard options?
Exotic options have more complex structures and payoffs tailored to specific financial needs, often depending on path or unique criteria.
Name three examples of exotic options.
Asian options, barrier options, and lookback options.
What is the main feature of Asian options?
Their payoff depends on the average price of the underlying asset over a period.
Why are Asian options less sensitive to extreme price movements?
Because they average out price fluctuations over time.
How are Asian options classified?
Into Average Price options and Average Strike options, based on whether the strike or payoff depends on the average.
Why are exotic options often harder to price than standard options?
Their complex payoffs and dependency on path or multiple assets make analytical solutions rare.
Which numerical method is commonly used to price Asian options?
Monte Carlo Simulations
What assumption can simplify the pricing of Asian options?
Assuming the average stock price is lognormally distributed.
What is a barrier option?
An option whose payoff depends on whether the underlying asset hits a specific price level.
Why might closed-form solutions not exist for certain exotic options?
Due to features like stochastic volatility or price jumps.
What does a variance swap pay out?
The difference between realized Variance and a strike variance.
What is realized variance?
It is calculated as the average squared daily logarithmic returns of an asset over a period.
Why are variance swaps used?
To hedge against unexpected increases in volatility.
How is the risk-neutral expected variance (EQ[RV]) derived?
By summing the prices of put and call options across a grid of strike prices.
What does a positive variance swap payoff indicate?
That realized variance exceeded the strike variance.
