Unusual Stock Options
Unusual, or exotic, stock options are elaborations of plain vanilla options. A vanilla option is the right, but not obligation, to purchase (via a call) or sell (via a put) 100 underlying shares at a predetermined price per share (the strike price) in return for an upfront premium paid to the option seller. American-style options allow the option holder to exercise the option any time up to the expiration date; European-style options can only be exercised on the expiration date. Exotic options add unique characteristics to puts and calls and therefore usually sell for larger premiums.
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Asian Options
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The payoff of an Asian option is dependent on the average price of the underlying stock during a specified time period. The distance between a stock's average price and the option's strike price determines the amount of payoff, if any. Some traders prefer Asian options because they are immune to the phenomenon of pinning. Pinning occurs on the expiration date when demand and supply pressures force a stock's price towards the nearest strike price. Since the final "price" of an Asian option's underlying stock is an average of stock prices over time, the last-day behavior of the underlying stock is largely irrelevant.
Lookback Options
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Lookback options pay off in an amount determined by the price history of the option. A floating-strike lookback pays off the maximum difference between the lowest (for calls) or highest (for puts) stock price during the holding period and the final stock price on the expiration date. In effect, the lowest or highest price stock price during the holding period becomes the strike price of the call or put, respectively. Fixed-strike lookbacks are also exercised on the expiration date, but are valued at the maximum difference between the underlying stock price and a fixed option strike price.
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Barrier Options
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These are options that pay off in one of four ways, depending on whether the underlying stock price pierces or fails to pierce the option strike price, or barrier. The four variants are: (1) Up-and-in: the stock price must climb above the strike to activate a call option; (2) Down-and-in: the stock price must fall below the strike to activate a put option; (3)Up-and out: a call option is deactivated if prices pierce the strike from below; and (4) Down-and-out: a put option is deactivated if prices fall below a strike from above.
Depending on the contract terms, deactivated options may return a portion of their premiums to buyers at expiration. Activation and deactivation are permanent -- a barrier option cannot change status due to subsequent price movements.
Binary Options
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Also known as digital or all-or-nothing options, binaries are bets on whether a stock price will be above (for calls) or below (for puts) the strike price on the expiration date. If true, the option pays a fixed amount; if false, it expires worthless. For example, the current price of XYZ Corp. stock is $91.25. A call with a strike price of $100 and expiring in two months will pay $1,000 if the stock closing price is at or above $100 on expiration day. Otherwise, it expires with zero value. The premium paid for the option is determined by the distance of the stock price from the strike on purchase day and the amount of time until expiration. An option pricing model, such as Black-Scholes, is used to determine the option premium on purchase day.
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