FX OPTIONS
Exotic Options
In a l l o ur a r t i c l e s unt i l now we ha v e f o c us e d on the s imp l e p ut and c a l l op t i ons a l s o known a s v ani l l a op t i ons and r e l a t e d s t r a t e g i e s . In th i s l a s t a r t i c l e we wi l l f o c us on e xo t i c op t i ons . Exo t i c
op t i ons
c h a r a c t e r i z e d by a g r e a t e r c o m p l e x i t y than tha t o f the c ommonl y t r a d e d v ani l l a o p t i o n s . V a n i l l a op t i ons
a r e
c o n s i d e r e d s imp l e s inc e the
pro f i l e
p a y o f f i s
c o n t i n u o u s and i s onl y d ep end ent on the v a lu e o f the und e r l y ing a t e xp i r y. Exo t i c op t i ons a r e e v e r y th ing e l s e - wh i ch i s a v e r y l a r g e d e f ini t i on . The r e f o r e , in th i s a r t i c l e we wi l l onl y f o c us on the v ani l l a op t i on wi th in and out f e a tur e s known a s knock-
44 FX TRADER MAGAZINE July - September 2010 a r e
in, kno c k- o ut , r e v e r s e - kno c k- in, and r e v e r s e - kno c k- out . Fur the rmo r e , we wi l l l o o k a t the Ame r i c an d i g i t a l op t i on one - t o u ch, no - t o u ch, and d o u b l e -no - t o u ch . The kno c k- o ut op t i on f unc t i ons by b e ing an
b a r r i e r i s a b o v e the s t r i ke f o r a c a l l op t i on o r the b a r r i e r i s b e l ow the s t r i ke f o r a p ut op t i on ( s e e Fi g ur e 1 and 2 f o r i l lus t r a t i ons o f the kno c k- o ut f e a tur e ) . The kno c k- in op t i on f unc t i ons by b e ing wo r th l e s s unl e s s the b a r r i e r i s t o u che d , in wh i ch c a s e i t c onv e r t s into a norma l v ani l l a op t i on . Ag a in the
r e v e r s e
t e rme d i s us e d i f the ba r r i e r i s p l a c e d whe r e the op t i on i s i n - t h e -mo n e y ( s e e Fi g ur e 3 and 4 f o r i l l us t r a t i ons ) . No t i c e tha t ho l d ing
a
kno c k- in and k n o c k - o u t
o rd ina r y v ani l l a op t i on, p ut o r c a l l , unl e s s a pr e - sp e c i f i e d b a r r i e r l e v e l i s r e a che d , o r t o u che d , b e f o r e e xp i r y. The opt i on i s t e rme d r e v e r s e i f the b a r r i e r i s p l a c e d whe r e the op t i on i s in- the -mone y. Tha t i s , i f the
b a s e d on the s ame b a r r i e r and v ani l l a op t i on s t r i ke i s the s ame a s ho l d ing the v ani l l a op t i on i t s e l f . The r e f o r e , the pr i c e o f ho l d ing a kno c k- in and a kno c k- o ut wi th the s ame b a r r i e r and s t r i ke sho u l d
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