A New Classification of Exotic Options

Tailor-made to fit investors' specific needs, exotic options are more efficient than traditional ones to the extent that they allow a better risk reallocation between economic agents. However, due to the increasing complexity of exotic options, it is necessary to have a well defined classification structure for these products for better use and control. This article proposes a new approach to classify and design exotic options. Using traditional option characteristics as benchmark, options are classified according to their associated degrees of exoticism, which depend on the violation of any combination of 5 traditional option characteristics. Accordingly, options are classified in the same group if they do not meet the same traditional conditions. In our methodology, 64 most frequently traded exotic options can be classified and 26 new exotic options can be created. This would help regulators and small investors to have a better understanding on complicated exotic options, so that they will be able to better price the associated riskiness of these products