Exotic Options

Discussion in 'Options' started by wdbaker, May 20, 2004.

  1. wdbaker


    Hi all,

    I would like to get a thread going about exotic options, specifically:
    American Barrier "One Touch"(Digital or Binary) & "No Touch" (Digital or Binary) Options.

    I would like to discuss strategies for using them:
    Hedge underlying positions using options...
    Hedge option positions using underlying...

    Here are some descriptions

    One Touch Digitals (description to follow)(I like to think of them as being similar to "Bull Call Spreads" or "Bear Put Spreads" as them have many of the same behaviors.)

    The No Touch Digitals would be the opposite of the One Touch (I like to think of them as being similar to "Bull Put Spreads" or "Bear Call Spreads" as them have many of the same behaviors.)

    One Touch Digitals


    One Touch Digitals provide the Buyer with a Fixed payout profile. The Buyer receives the same payout irrespective of how far in the money the option closes. Unlike ordinary Digitals, One Touch Digitals payout if the underlying reaches the strike AT ANY TIME from start to maturity. They can therefore be considered as an American style Digital Option and the straight Digital as European style (i.e. exercise only at maturity, see "Digital Options").


    An investor may have the view that Oil (West Texas Intermediate), will rally above USD20 at some time in the next six months (current price USD 18.20). However the investor is not sure that Oil will CLOSE above USD20 at the end of six months, so they purchase a One Touch Digital option on WTI at a strike of USD20.00. For this option, the underlying is defined as the front futures contract quoted on Reuters PPNI. Should the front contract ever trade above USD20 in the next six months, the investor will receive USD1.00 per barrel. The cost of this option is USD 0.55 cents. For 100,000 barrels, the cost is therefore USD 55,000 and the payout is USD100,000.


    The Digital is generally priced with the payout fixed at 100. The premium is then adjusted. This allows a simple analysis in terms of the payout ratio. For example, if the Digital costs 55c and the payout is 100 cents, the Digital has a payout ratio of 1.818 to 1. The Digital price is influenced by the same factors as a RECEIVER or PAYER.


    This is an ideal alternative to CALLS and PUTS when the expected movement in rates is limited as the Digital payout is large for a small movement in rates.


    Payout is earned is underlying hits strike AT ANY TIME

    Payout same whether in the money by 1c or 1000c

    Currency protected if required

    High return characteristics

    Lower premiums than alternatives


    Limits profit potential


    Digitals: Simple Aggressive

    To the Moderators,
    I could have placed this under Forex as most of these exotic options are used for Forex but felt that I would get much more participation from the highly sophisticated group that deals with Options. Please allow it some time, I have lots of thoughts that will spark discussions etc... as I have time to post.

  2. wdbaker


    I am currently trading the "No Touch" options as a strangle and trying to devise ways to hedge them in the futures market(FX).

    I am open to other creative uses of these options and will answer any questions that I can regarding them.

    I am not an expert in exotics options.

    Also trying to understand how to roughly price them, establish greeks etc... The companies who sell them do not provide much in the way of analytics unlike vanilla options.

    wdbaker Denver, Co