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Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading


The recent financial crisis brought to light many of the misunderstandings and misuses of exotic derivatives. With market participants on both the buy and sell-side having been found guilty of not understanding the products they were dealing with, never before has there been a greater need for clarification and explanation.

Exotic Options and Hybrids is a practical guide to structuring, pricing and hedging complex exotic options and hybrid derivatives that will serve readers through the recent crisis, the road to recovery, the next bull market and beyond. Written by experienced practitioners, it focuses on the three main parts of a derivative’s life: the structuring of a product, its pricing and its hedging.

Divided into four parts, the book covers a multitude of structures, encompassing many of the most up-to-date and promising products from exotic equity derivatives and structured notes to hybrid derivatives and dynamic strategies. Based on a realistic setting from the heart of the business, inside a derivatives operation, the practical and intuitive discussions of these aspects make these exotic concepts truly accessible.

Adoptions of real trades are examined in detail, and all of the numerous examples are carefully selected so as to highlight interesting and significant aspects of the business. The introduction of payoff structures is accompanied by scenario analysis, diagrams and lifelike sample term sheets. Readers learn how to spot where the risks lie to pave the way for sound valuation and hedging of such products. There are also questions and accompanying discussions dispersed in the text, each exploited to illustrate one or more concepts from the context in which they are set.

The applications, the strengths and the limitations of various models are highlighted, in relevance to the products and their risks, rather than the model implementations. Models are de-mystified in separately dedicated sections, but their implications are alluded to throughout the book in an intuitive and non-mathematical manner.

By discussing exotic options and hybrids in a practical, non-mathematical and highly intuitive setting, this book will blast through the misunderstanding of exotic derivatives, enabling practitioners to fully understand and correctly structure, price and hedge theses products effectively, and stand strong as the only book in its class to make these “exotic” concepts truly accessible.

MOHAMED BOUZOUBAA is an experienced practitioner in the world of derivatives, and is currently Head of Derivatives Trading and Structuring at CDG Capital. His professional expertise spans the spectrum of topics in exotic options and hybrids having held positions in Equity Derivatives Sales at Société Générale in Paris, as a Risk and Fund Management expert at Sophis specializing in the risks involved in equity, credit and fixed income derivatives, and as a derivatives structurer at Bear Stearns/JP Morgan Chase in London and Equity Structured Products Manager at First Gulf Bank in Dubai. Mohamed holds masters degrees in Financial Engineering and in Applied Mathematics.

ADEL OSSEIRAN is a mathematician by training. His work as a financial practitioner in derivative pricing includes working in front office roles as a quantitative analyst and as a derivatives structurer in London. He studied Mathematics at the University of Oxford and to PhD level in Financial Mathematics at Imperial College London.

List of Symbols and Abbreviations.



1 Basic Instruments.

1.1 Introduction.

1.2 Interest Rates.

1.3 Equities and Currencies.

1.4 Swaps.

2 The World of Structured Products.

2.1 The Products.

2.2 The Sell Side.

2.3 The Buy Side.

2.4 The Market.

2.5 Example of an Equity Linked Note.

3 Vanilla Options.

3.1 General Features of Options.

3.2 Call and Put Option Payoffs.

3.3 Put–call Parity and Synthetic Options.

3.4 Black–Scholes Model Assumptions.

3.5 Pricing a European Call Option.

3.6 Pricing a European Put Option.

3.7 The Cost of Hedging.

3.8 American Options.

3.9 Asian Options.

3.10 An Example of the Structuring Process.

4 Volatility, Skew and Term Structure.

4.1 Volatility.

4.2 The Volatility Surface.

4.3 Volatility Models.

5 Option Sensitivities: Greeks.

5.1 Delta.

5.2 Gamma.

5.3 Vega.

5.4 Theta.

5.5 Rho.

5.6 Relationships between the Greeks.

5.7 Volga and Vanna.

5.8 Multi-asset Sensitivities.

5.9 Approximations to Black–Scholes and Greeks.

6 Strategies Involving Options.

6.1 Traditional Hedging Strategies.

6.2 Vertical Spreads.

6.3 Other Spreads.

6.4 Option Combinations.

6.5 Arbitrage Freedom of the Implied Volatility Surface.

7 Correlation.

7.1 Multi-asset Options.

7.2 Correlation: Measurements and Interpretation.

7.3 Basket Options.

7.4 Quantity Adjusting Options: "Quantos".

7.5 Trading Correlation.


8 Dispersion.

8.1 Measures of Dispersion and Interpretations.

8.2 Worst-of Options.

8.3 Best-of options.

9 Dispersion Options.

9.1 Rainbow Options.

9.2 Individually Capped Basket Call (ICBC).

9.3 Outperformance Options.

9.4 Volatility Models.

10 Barrier Options.

10.1 Barrier Option Payoffs.

10.2 Black–Scholes Valuation.

10.3 Hedging Down-and-in Puts.

10.4 Barriers in Structured Products.

11 Digitals.

11.1 European Digitals.

11.2 American Digitals.

11.3 Risk Analysis.

11.4 Structured Products Involving European Digitals.

11.5 Structured Products Involving American Digitals.

11.6 Outperformance Digital.

12 Autocallable Structures.

12.1 Single Asset Autocallables.

12.2 Autocallable Participating Note.

12.3 Autocallables with Down-and-in Puts.

12.4 Multi-asset Autocallables.


13 The Cliquet Family.

13.1 Forward Starting Options.

13.2 Cliquets with Local Floors and Caps.

13.4 Reverse Cliquets.

14 More Cliquets and Related Structures.

14.1 Other Cliquets.

14.2 Multi-asset Cliquets.

14.3 Napoleons.

14.4 Lookback Options.

15 Mountain Range Options.

15.1 Altiplano.

15.2 Himalaya.

15.3 Everest.

15.4 Kilimanjaro Select.

15.5 Atlas.

15.6 Pricing Mountain Range Products.

16 Volatility Derivatives.

16.1 The Need for Volatility Derivatives.

16.2 Traditional Methods for Trading Volatility.

16.3 Variance Swaps.

16.4 Variations on Variance Swaps.

16.5 Options on Realized Variance.

16.6 The VIX: Volatility Indices.

16.7 Variance Dispersion.


17 Asset Classes (I).

17.1 Interest Rates.

17.2 Commodities.

18 Asset Classes (II).

18.1 Foreign Exchange.

18.2 Inflation.

18.3 Credit.

19 Structuring Hybrid Derivatives.

19.1 Diversification.

19.2 Yield Enhancement.

19.3 Multi-asset Class Views.

19.4 Multi-asset Class Risk Hedging.

20 Pricing Hybrid Derivatives.

20.1 Additional Asset Class Models.

20.2 Copulas.

21 Dynamic Strategies and Thematic Indices.

21.1 Portfolio Management Concepts.

21.2 Dynamic Strategies.

21.3 Thematic Products.


A Models.

A.1 Black–Scholes.

A.2 Local Volatility Models.

A.3 Stochastic Volatility.

A.4 Jump Models.

A.5 Hull–White Interest Rate Model and Extensions.

B Approximations.

B.1 Approximations for Vanilla Prices and Greeks.

B.2 Basket Price Approximation.

B.3 ICBC/CBC Inequality.

B.4 Digitals: Vega and the Position of the Forward.