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Exotic Options - Pricing, Hedging and Applications

Duration: 3 days
  • Modelling Issues and Valuation Methods
  • Barrier, Average Rate and Look-back Options
  • Binary, Digital and Touch Options
  • Compound, Chooser, Power, Log and Shout Options
  • Exchange, Rainbow, Basket and Quanto Exotic Options
  • Hedging with Exotic Options
  • Financial Engineering with Exotic Options
  • Managing Risks of Exotic Options Portfolios
The objective of this advanced-level course is to give you a good understanding of the mechanics, pricing, risk characteristics and applications of exotic options.

We start with a general introduction to exotics options, explaining the differences between “vanilla” and “exotic” options and giving an overview of exotic options, their pay-off profiles, and their applications.

Further, we present a general framework for valuing exotic options. Models include analytical as well as numerical models and Monte Carlo simulation techniques.

We then take a closer look at the various types of exotic options: such as Asian, lookback, barrier, basket, compound, ladder, clique, chooser, contingent premium and rainbow options. We establish the pay-off profiles of these options and explain how they can be decomposed into more basic “building blocks” – such as vanilla options and digital options - for analysis and structuring purposes.

Further, we explain how the options are priced and hedged, and how the traditional “greeks” – delta, gamma, vega, theta and rho – as well as higher order sensitivities such as “speed”, “color” and “charm” - are calculated and interpreted.

We also explain how the individual exotic options can be used for the hedging of commercial foreign exchange transactions, complex market risk exposures, and as building blocks in “exotic” structured products.

Finally, we present and discuss ways of effectively managing the risk of a portfolio of exotic options. We explain how to establish a “risk warehouse” and how this risk warehouse can be managed using standard derivatives, structured products and dynamic hedging techniques.

Day One

09.00 - 09.15 Welcome and Introduction

09.15 - 12.00 Introduction to Exotic Options

  • What is an “Exotic Option“?
  • Types of Exotic Options
  • Classification of Exotic Options
  • Overview of Applications

Modelling Issues and Valuation Methods

  • Review of concepts in option pricing theory
  • Black-Scholes Model
  • Cox-Ross-Rubinstein binomial model
  • Generating Payoffs
  • Approaches to Hedging
  • Monte Carlo Toolkit
  • Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Path-Dependent Options (1): Barrier Options

  • Definitions and characteristics
  • Types of Barrier Options
    • Knock-in and Knock-out
    • Single and Double Barriers
  • Modelling Pay-Offs
  • Pricing and Hedging
  • Risk Sensitivities
    • Delta, Gamma, Vega etc.
    • A Closer Look at the Behaviour of “Greeks” Around the Barriers
  • Examples of Applications
    • Reducing Hedging Costs with Barrier Options
  • Exercise (Double Barrier Option with Rebate)

Day Two

09.00 - 09.15 Recap

09.15 - 12.00 Path-Dependent Options(2): Asian Options

  • Average Rate and Average Strike
  • Averaging methods
  • Modelling pay-offs
  • Pricing and Hedging
  • Practical Applications and Exercises

Path-Dependent Options(3): Look-Backs, Ladders and Ratchet Options

  • Look-Back and Look-Forward Options
  • Ratchet (Clique) Options
  • Ladder Options
  • Pay-offs Types (Sampling of Max/Min)
  • Pricing and Valuation Issues
  • Cases and Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Discrete Pay-Off Options

  • Euro-Digital Options
  • Contingent Premium Options
  • One and Two Touch / American Digitals
  • Double No-Touch
  • Pricing
  • Examples of Applications
  • Exercise

Other Options

  • Compound Options
  • Chooser Options
  • Pay Later (Contingent Premium) Options
  • Delayed Options
  • Pricing
  • Examples of Applications
  • Exercises

Day Three

09.00 - 09.15 Recap

09.15 - 12.00 Multivariate Options

  • Basket Options
  • Rainbow Options
    • “Best of”/ “Worst of” Options
    • Option on the Max or Min of N Assets
    • Multi-Strike Options
    • Spread Options
    • Exchange Options
  • Applications of Multivariate Options
  • Exercise

Quanto Options

  • Definitions and Characteristics
  • Types of Quanto Options
  • Pricing of Quanto Derivatives
  • Examples of Applications

12.00 - 13.00 Lunch

13.00 - 16.30 Financial Engineering with Exotic Options

  • Purpose of Constructing of Exotic Structures
  • Plain vs. Embedded Exotics
  • Examples
    • Range Floaters
    • Continuous Accrual Currency Note with a One-Touch Knock-out Range
    • Up-and-Out Indexation
    • Step-Lock and Clique Structures

Risk Management of Exotic Options

  • Effectively Managing the Risks of a Portfolio of Exotic Options

Evaluation and Termination of the Seminar