Derivatives Explained: Forwards, Futures, Swaps, and Options as Building Blocks
Book: Structured Finance and Insurance: The ART of Managing Capital and Risk Author: Christopher L. Culp Publisher: Wiley Finance, 2006 ISBN: 978-0-471-70631-1
Exotic options
Exotic Options Grab Bag: Shouts, Ladders, and Parisians
By this point in the book, Wilmott has been classifying exotic options into tidy categories. Asian options got their own chapter. Lookbacks got their own chapter. Barrier options got their own chapter. But the universe of exotic derivatives is large and growing, and eventually the classification exercise breaks down. Chapter 28 is where Wilmott gives up on neat categories and just throws a bunch of interesting exotics at us. It is a grab bag, and it is fun.
Derivatives and Stochastic Control: Passport Options
Most options we have seen so far give the holder a choice at one specific moment. With a European option, you decide at expiry. With an American option, you pick the best time to exercise. But what if the option let you actively trade during its entire life, and then insured you against losses? That is the idea behind the passport option, and Chapter 27 of Wilmott’s book uses it to introduce stochastic control.
Lookback Options: Buying at the Low, Selling at the High
Every trader has the same fantasy: buy at the absolute lowest price and sell at the absolute highest. You can buy a contract that pays you as if you did. That is the lookback option, Chapter 26.
Asian Options: Pricing Based on Averages
Asian options are probably the most practical exotic derivatives. In crude oil markets, they are not even considered exotic. They are the vanilla. Chapter 25 applies the framework from Chapter 24 to options whose payoff depends on an average price.
Strongly Path-Dependent Derivatives: When History Matters
Barrier options showed us weak path dependence. The contract cared about the path, but we still solved a two-variable problem. Chapter 24 takes the next step: strong path dependence. Cannot be hidden in boundary conditions. We need an extra variable.
Barrier Options: Knock-Ins, Knock-Outs, and How They Work
Barrier options used to be exotic. Now they are one of the most heavily traded option types. Chapter 23 goes deep on them. Simple enough to understand, useful enough to be everywhere, tricky enough to mess up if you do not pay attention.
Exotic Derivatives: Beyond Vanilla Options
We have spent a lot of time on vanilla calls and puts. But now Wilmott opens Part Two of the book, and things get interesting. Chapter 22 introduces exotic derivatives, contracts that keep quants employed and traders nervous.