Exotic options sure sound interesting, but are they really right for you? Exotic asset trading offers big payouts but comes with big risks too. Therefore, make sure you know what you’re signing up for.
I’ll break down some things to think about. Some pros might grab your interest, but there are cons to weigh as well. Not everything is for everyone, so look closely at what really fits for your goals long-run.
First, Let’s See What Are Exotic Options
While standard options just give you the choice to buy or sell something by a certain date, exotics tweak things to suit different investing styles.
They can add new layers to the basics. Things like multiple assets, multiple dates, or special ways of calculating gains and losses. Some let you bet on relationships between two stocks moving in sync. Others have triggers that activate payouts depending on certain conditions being met.
The customizability is what draws people in, but it makes them harder to wrap your head around too. With regular options, the payoff formula stays simple no matter what. These exotic varieties cook up new recipes that complicate the math.
Types of Exotic Options
There are different kinds of exotic options out there. Some have triggers that depend on prices hitting certain levels, while others average prices over time instead of using the final value. Then you got types that give a set payout no matter what prices do.
Options that watch for price triggers are called barrier options. They’ll only provide a payoff if the stock stays above or below a target you set. Meanwhile, Asian options look at the average price over weeks or months rather than just the closing price.
Binary options are more straightforward – they pay a fixed amount if closing above or below a strike, nothing otherwise. No matter the performance in between.
Each type changes up the basic option structure to suit specific goals. Triggers could make sense if you want extra insurance on a current holding. Averaging suits folks focused on long-term trends. And binaries appeal to those wanting simple payouts.
Customization and Flexibility
You can tweak the details like the price targets, dates, and payout formulas to make the trade fit your goals exactly. Certain trading apps like “Immediate Edge” can help you do that.
That means you aren’t stuck with only one approach. If regular options don’t quite align with your strategy, maybe an exotic could be tailored to suit your style better.
Want a higher or lower strike to adjust your odds and rewards? Exotics let you set it to your liking. Their complex payout formulas can also architect very specific profit or insurance scenarios compared to simple calls and puts.
This personalization is handy since no two investors are quite alike. With exotics, you aren’t forcing your trade into a procrustean bed of standardized terms. Instead, you can hammer out the specifics to get just the risk and profit balance you want.
Of course, more complex means more that could go wrong. But the flexibility is a nice bonus.
Why Some Investors Should Stay Away From Exotics?
First off, these types of trades can get pretty complicated compared to your basic calls and puts. They’ve got all kinds of extra bells and whistles that change up how they work. Now for some folks, that extra customization is awesome because it lets them place really specific bets. But it also means there’s more to wrap your head around.
If you’re just starting out trading options, exotics might be more than you want to take on at first. There’s nothing wrong with keeping things simple while you’re learning the ropes. But if you enjoy figuring out all the in’s and out’s, then go for it. Just know it’ll take some extra study time on your part to avoid any surprises down the road.
Next is costs. Usually there’s higher minimums to get in on an exotic trade versus regular options. Plus you might need to use a specialized broker which could tag on more fees. So before placing an order, think about if you’ve got enough cash on hand to play without putting yourself in a tight spot financially.
Then you got to check how often the exotic you want is trading. Low volume stuff can be riskier cause the prices might change more wildly when you go to buy or sell. Make sure there’s enough activity so you aren’t stuck holding on too long if your view changes.
A lot of exotics work better for shorter term moves rather than long-term investing. And your goals might be different too if you’re more conservative. So just double check the trade aligns with how long you want to hold it for versus cashing out quickly.
But You Can Still Add Them To Your Portfolio
Rather than relying solely on exotic options alone, incorporating them strategically alongside traditional assets can help optimize returns and manage risk.
Exotic options provide customization that appeals to sophisticated investors. However, due to their complexity and potential illiquidity, they are not always suitable as a standalone allocation. By pairing exotic positions with liquid, standardized options that provide baseline exposure and downside protection, an investor can benefit from the personalized upside of exotic structures while also ensuring baseline stability.
Diversifying across both exotic and traditional derivatives allows an portfolio to capitalize on varied opportunities through different market conditions. Standard options on stable underlies can generate steady, uncorrelated income regardless of broader volatility.
Meanwhile, exotic options targeted at specific views present asymmetric risk-reward potential. Together, this hybrid approach constructs a risk portfolio with multiple independent return drivers.
The Bottom Line
And in the end, the reality is that exotic options can be too risky. Therefore, they are not so good for those who prefer going all-in with their investments. But still, it can be a decent add-on to your strategy. If you are lucky enough to pick the right one, it may turn into a significant profit. Just never go over your limits with this type of investments.