FRM Part I · FRM Exam Part I · Exotic Options
Which statement correctly distinguishes a path-dependent exotic option from a non-path-dependent one?
A path-dependent option has a payoff that depends on the underlying's price history during the life of the option, not just its final price. Asian, lookback and barrier options are examples. The other statements are wrong about trading venue, payoff linearity and premium.
- AThe payoff of a path-dependent option depends on the price history of the underlying, not only its terminal valueCorrect
- BA path-dependent option can only be traded on exchanges, never over the counter
- CA path-dependent option always has a payoff that is a linear function of the terminal price
- DA path-dependent option always has a lower premium than a comparable standard option
Explanation
Path dependence means the payoff is affected by how the underlying moved over the option's life, as in Asian, lookback and barrier options. Exotic options mostly trade OTC, payoffs are generally nonlinear, and premiums can be higher or lower than vanilla options.
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