Skip to content

FRM Part I · FRM Exam Part I · Exotic Options

A bank sold a forward-start-free, one-year down-and-in put and wants to hedge it. Which feature makes barrier options such as this harder to hedge dynamically than vanilla options when the spot is close to the barrier?

Barrier options are hard to hedge near the barrier because delta and gamma change sharply, sometimes discontinuously, as the spot approaches the barrier level. This forces large, frequent and costly rebalancing trades, unlike vanilla options whose Greeks vary smoothly.

  1. ADelta and gamma can change sharply and discontinuously near the barrier, making hedge rebalancing costly and unstableCorrect
  2. BDelta is always exactly zero near the barrier, so no hedge is needed
  3. CVega becomes constant and equals the vanilla vega
  4. DThe option's price becomes independent of the underlying's volatility

Explanation

Near a barrier the option's value changes abruptly, so delta and gamma can become very large and may change sign, producing costly and unstable hedging. Delta is not zero, and price remains volatility dependent.

Did you get it right without looking?

One question tells you little. A timed set on Exotic Options shows your real accuracy, how long you take and where you lose marks.

Practise Exotic OptionsFree diagnostic mock

More Exotic Options questions