Glossary: Exotic and Volatility Products

This glossary provides definitions for key terms used in exotic options, volatility products, and structured notes. Terms are organized alphabetically for quick reference.

A-D

Asian Option: An option whose payoff depends on the average price of the underlying asset over a specified period, rather than just the price at expiration.

At-the-Money (ATM): An option with a strike price equal or very close to the current underlying price.

Auto-Callable: A structured product that automatically redeems (calls) early if the underlying asset exceeds a specified level on observation dates.

Barrier Option: An option that is either activated (knock-in) or terminated (knock-out) when the underlying price reaches a specified barrier level.

Best-of Option: An option whose payoff is based on the best-performing asset in a basket of underlyings.

Binary Option: See Digital Option.

Chooser Option: An option that allows the holder to choose whether it becomes a call or put at a specified future date.

Cliquet Option: An option that locks in returns periodically, with each period's gain added to the final payoff.

Compound Option: An option on an option—the right to buy or sell another option at a specified premium.

Contingent Premium Option: An option where premium is paid only if the option expires in-the-money.

Contango: A futures term structure where longer-dated contracts trade at higher prices than shorter-dated contracts, common in VIX futures during calm markets.

Correlation: A statistical measure of how two assets move together, ranging from -1 (perfectly opposite) to +1 (perfectly together).

Digital Option: An option that pays a fixed amount if the underlying finishes above (call) or below (put) a strike price at expiration.

Dispersion Trade: A strategy that profits when individual assets in an index move independently, typically involving selling index volatility and buying single-stock volatility.

Down-and-In: A barrier option that becomes activated when the underlying falls below a specified barrier level.

Down-and-Out: A barrier option that terminates when the underlying falls below a specified barrier level.

E-K

Exotic Option: Any option with features beyond standard European or American calls and puts, including path-dependent, multi-asset, or complex payoff structures.

Himalaya Option: An exotic option where the best-performing asset each period is locked in and removed from the basket for remaining observations.

Implied Correlation: The correlation level implied by the difference between index option prices and individual component option prices.

Implied Volatility: The volatility level that, when input into an option pricing model, produces the observed market price.

In-the-Money (ITM): An option with positive intrinsic value—calls where spot exceeds strike, puts where strike exceeds spot.

Knock-In: A barrier option feature that activates the option when the barrier is reached.

Knock-Out: A barrier option feature that terminates the option when the barrier is reached.

L-P

Lookback Option: An option whose payoff depends on the maximum or minimum price achieved by the underlying during the option's life.

Monte Carlo Simulation: A numerical method for pricing derivatives by simulating many possible price paths and averaging the discounted payoffs.

Out-of-the-Money (OTM): An option with no intrinsic value—calls where strike exceeds spot, puts where spot exceeds strike.

Path-Dependent: An option whose payoff depends on the price history of the underlying, not just the terminal price.

Pin Risk: The risk that a stock closes exactly at an option strike at expiration, creating uncertainty about exercise.

Put Spread: A strategy involving buying a put at one strike and selling a put at a lower strike.

R-S

Rainbow Option: An option whose payoff depends on multiple underlying assets, often paying based on the best or worst performer.

Realized Volatility: The actual volatility experienced by an asset over a historical period, typically calculated from daily returns.

Rebate: A payment made when a barrier option is knocked out, partially compensating the holder.

SABR Model: A stochastic volatility model commonly used to interpolate implied volatility across strikes at a given expiration.

Straddle: A strategy combining a call and put with the same strike and expiration, profiting from large moves in either direction.

Strangle: A strategy combining an out-of-the-money call and out-of-the-money put, profiting from large moves.

Structured Note: A debt security with returns linked to an underlying asset through embedded derivatives.

SVI (Stochastic Volatility Inspired): A parametric formula for fitting the implied volatility smile.

T-V

Tail Risk: The risk of extreme market moves that occur in the tails of return distributions, typically more frequent than normal distributions predict.

Term Structure: The pattern of implied volatility or futures prices across different maturities.

Up-and-In: A barrier option that becomes activated when the underlying rises above a specified barrier level.

Up-and-Out: A barrier option that terminates when the underlying rises above a specified barrier level.

Vanna: The sensitivity of delta to changes in implied volatility, or equivalently, the sensitivity of vega to changes in the underlying price.

Variance Swap: A derivative that pays the difference between realized variance and a fixed variance strike, providing pure exposure to volatility squared.

VIX (CBOE Volatility Index): A measure of expected 30-day implied volatility of the S&P 500, calculated from option prices.

Volatility Risk Premium: The difference between implied volatility (expected) and realized volatility (actual), typically positive for equities.

Volatility Smile: The pattern of higher implied volatility for out-of-the-money options compared to at-the-money options.

Volatility Swap: A derivative that pays the difference between realized volatility and a fixed volatility strike.

Volga: The sensitivity of vega to changes in implied volatility, also called vomma.

W-Z

Worst-of Option: An option whose payoff is based on the worst-performing asset in a basket of underlyings.

Abbreviations

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This glossary is updated periodically. For detailed explanations and examples, see the related articles linked below.

Related articles:

• For VIX products, see Volatility Futures and Options (VIX) Overview
• For variance swaps, see Variance and Volatility Swap Mechanics