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A Course in Financial Calculus by Alison Etheridge

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6 Different payoffs

Summary

Most of the concrete examples of options considered so far have been the standard examples of calls and puts. Such options have liquid markets, their prices are fairly well determined and margins are competitive. Any option that is not one of these vanilla calls or puts is called an exotic option. Such options are introduced to extend a bank’s product range or to meet hedging and speculative needs of clients. There are usually no markets in these options and they are bought and sold purely ‘over the counter’. Although the principles of pricing and hedging exotics are exactly the same as for vanillas, risk management requires care. Not only are these exotic products much less liquid than standard options, but they often ...

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