FRM Part I · FRM Exam Part I · Exotic Options
A corporate treasurer wants protection against a rise in the average price of jet fuel over the next twelve months, because the firm buys fuel in roughly equal amounts every month. Which exotic option is best suited to this exposure?
An Asian option on the average fuel price is best, because the firm buys fuel evenly through the year and its cost depends on the average price. Its payoff tracks that average, whereas barrier, digital and lookback options do not match the exposure.
- AAsian option on the average fuel priceCorrect
- BBarrier knock-out option on the spot fuel price at expiry
- CDigital option paying a fixed amount if spot exceeds the strike
- DLookback option on the maximum fuel price
Explanation
An Asian option pays off on the average price over a period, which matches the firm's repeated monthly purchases. A knock-out barrier option can vanish before the exposure ends. A digital option pays a fixed sum and does not scale with the cost increase. A lookback option pays on an extreme price that the firm does not actually pay.
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