Exotic Options Trading

Exotic Options Trading covers conventional options, digital options, barrier options, cliquets, quanto options, outperformance options and variance swaps, and explains difficult concepts in simple terms, with a practical approach that gives the reader a full understanding of every aspect of each exotic option. The book also discusses structured notes with exotic options embedded in them, such as reverse convertibles, callable and puttable reverse convertibles and autocallables and shows the rationale behind these structures and their associated risks.

Introduction:

This book is appropriate for people who want to get a good overview of exotic options in practice and are interested in the actual pricing of them. When dealing with exotic options it is very important to quantify the risks associated with them and at which stock or interest rate levels the Greeks change sign. Namely, it is usually the case that the Greeks of exotic options show much more erratic behaviour than the Greeks of regular options. This instability of the Greeks forces the trader to choose different hedging strategies than the standard option model would prescribe. Therefore the risk management of exotic options entails much more than just obeying the model, which in turn has an impact on the price.

The non-standard risk management of exotic options means that when pricing an exotic option, one first needs to understand where the risks lie that affect the hedging strategy and hence the pricing of the particular exotic option. Once the risks have been mapped and the hedging strategy has been determined, the actual pricing is often nothing more than a Monte Carlo process. Moreover, when knowing the risks, the actual pricing of an exotic option can in some cases even be replicated by a set of standard options. In other words, the starting point for pricing exotic options is to have a full awareness of the risks, which in turn has an impact on how one needs to accurately price an exotic option.

The aim of this book is to give both option practitioners and economics students and interested individuals the necessary tools to understand exotic options and a manual that equips the reader to price and risk manage the most common and complicated exotic options. To achieve this it is imperative to understand the interaction between the different Greeks and how this, in combination with any hedging scheme, translates into a real tangible profit on an exotic option. For that reason, this book is written such that for every exotic option the practical implications are explained and how these affect the price. Knowing this, the necessary mathematical derivations and tools are explained to give the reader a full understanding of every aspect of each exotic option. This balance is incredibly powerful and takes away a lot of the mystique surrounding exotic options, turning it into useable tools for dealing with exotic options in practice.

This book discusses each exotic option from four different angles. First, it makes clear why there is investor demand for a specific exotic option. Secondly, it explains where the risks lie for each exotic option and how this affects the actual pricing of the exotic option. Thirdly, it shows how to best hedge any vega or gamma exposure embedded in the exotic option. Lastly, for each exotic option the skew exposure is discussed separately. This is because any skew exposure is typically harder to quantify, but it has a tremendous impact on almost every exotic option. For that reason, this book devotes a separate section to skew, Chapter 5, which explains skew and the reasons for it in depth.

Contents:

• Conventional Options, Forwards and Greeks
• Profit on Gamma and Relation to Theta
• Delta Cash and Gamma Cash
• Skew
• Simple Option Strategies
• Monte Carlo Processes
• Chooser Option
• Digital Options
• Barrier Options
• Forward Starting Options
• Ladder Options
• Lookback Options
• Cliquets
• Reverse Convertibles
• Autocallables
• Callable and Puttable Reverse Convertibles
• Asian Options
• Quanto Options
• Composite Options
• Outperformance Options
• Best of andWorst of Options
• Variance Swaps
• Dispersion
• Engineering Financial Structures

Exotic Options Trading By Frans de Weert pdf