Question

The current stock price is $75. After six months, it either goes up by the factor u = 1.20 or it goes down by the factor d = 0.80. The continuously compounded risk-free rate is 6% per year. Consider an exotic option whose payoff after six months is given by the stock price S(T) squared less a strike price (K = $7,500) if it has a positive value, zero< otherwise, that is: max[S(T)² – 7,500, 0]. What is the price of the exotic option?

Answer 1

Exotic option are option which is not similar or is different from the normal option or vannila option in terms of payment, structure etc. When vanilla option allows to buy in case of a call and sell in case of a put whereas in exotic option differs from it it has various options available similar to a rainbow and also increased risk associated.

Pricing associated with exotic option is a complex process. Ther pricing is closely related to future market scenarios as well. .