Digital Options and Exotic Options

digital option is also known by the name of binary options where the outcome of a trade has only two possibilities, either a full predetermined amount in case of the trade being “in the money” or nothing in case of the trade being “out of money”.

Exotic options can be defined as those options that have a certain clause added to them which state that the option would be only active until the stock hits a specified price. Else the exotic option lies worthless. It is different from the common European or American options in terms of the underlying asset or the calculation of when and how the trader would receive the predetermined payout. The exotic options are generally traded over the counter as they are more complex than the options that are traded on an exchange. The exotic option strategies are best suited to those traders who want more flexibility in their trading. The different types of exotic options are:

  • Barrier options
  • Asian options
  • Compound options
  • Bermuda options
  • Himalaya options
  • Chooser options
  • Digital options

The differences between the digital options and exotic options are as follows:

1. Simplicity: the digital options are simple to understand and operate. On the other hand the exotic options are complex and not very simple to operate.

2. Place of trade: the digital options are simple to trade and are generally traded on stock exchanges whereas the complex exotic options are traded over the counter.

3. Not for individual traders: the exotic options are complex options which are the tools of the multi million dollar traders who are backed by big financial institutions and banks. They are not traded by individual traders because of the complexity. On the other hand, the digital options are traded by individual traders.

4. Expense and liquidity: the digital options are less expensive and more liquid than the exotic options which are expensive and illiquid. Because of this they are not traded by individual traders.

These are the main differences between digital options and exotic options, however digital options is a part of exotic options. But due to the complex nature of the exotic options they are generally not traded by individual traders but by traders who have the backing of big banks and financial institutions. Therefore it depends on traders to adopt various strategies to trade profitably and employ various options available under these options.