Chapter 4

We refer to simple exotic options as those that are path-independent and involve only a single underlying asset X and a single expiration date T. Generally, such simple exotic options will have a payoff function V(x, T) = f(x) which is different from a vanilla European call or put option. Often the function f(x) can be decomposed into a sum of simpler contracts that have already been priced. In that case, the price of the derivative is then, by the Principle of Static Replication, equal to the price of the replicating portfolio. We shall meet many examples of this basic idea, not only in this chapter, but also in later chapters on more complex derivatives.

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