What is an Exotic Option?
How Does an Exotic Option Work?
Exotic options contain complex criteria affecting valuation and payoff. In many cases these criteria are time-sensitive and allow the holder to exercise specific preferences at various points prior to the expiration date. Examples of exotic options include Asian options (strike price is based on the projected average price of the underlying asset over a specific interval) and compound options (underlying asset is another option). Exotic options should not be confused with plain vanilla options, which only contain a specific strike price, expiration date, and underlying asset.
Why Does an Exotic Option Matter?
The complexities associated with exotic options make them difficult to trade on an exchange. As a result, most exotic options are traded in the over-the-counter (OTC) market.