option contracts that are variations on simple puts and calls or are different products with optionality built into them. Exotic options are available in various asset classes on which options are available, but are mostly found in the foreign exchange market. A common example is the barrier option, which itself comes in various forms such as knock-in options and knock-out options (and reversed versions of both) that can be either single-barrier options or double-barrier options. What those terms refer to and what barrier options have in common are one or two trigger prices that, if touched, will cause an option with predetermined characteristics to be created (knock-in option) or will cause an existing option to cease to exist (knock-out option). A double-barrier option has barriers on either side of the exercise price (i.e., one trigger price is higher than the strike price and the other is lower), whereas a single-barrier option has one trigger price that may be higher or lower than the strike price. Barrier options, because they risk either not being knocked in, or being knocked out, are cheaper than ordinary puts and calls, and a double knockout option is cheaper than a single knockout option.
Other examples of exotic options: basket options, which give the owner the right to receive two or more designated foreign currencies in exchange for a base currency, either at a prearranged rate of exchange or at the prevailing spot market rate; compound options, which are options on options, whereby the holder has the right to purchase another option at a pre-set date, at a pre-set option premium (a put on a call or a call on a put or a put on a put or a call on a call), and are used by corporations to hedge the foreign exchange risk of an uncertain acquisition or by speculators to bet on the volatility of volatility; Bermuda options, which combine the attributes of an american-style option and a european-style exercise; all-ornothing options that pay out a set amount if the underlying asset price is above or below the exercise price at the time of expiration; best-of-two options that pay off based on the independent performances of two different securities or indexes, or better-of-two options that pay off on the better performing of two underlying assets or indexes; and others.
