Differences between Exotic and Vanilla Foreign Exchange Options

One of the most commonly-transacted derivative financial instruments in the stock market are the stock options. Basically, stock options are preemptive rights to purchase a specified number of a company’s stock on an agreed future determinable time. There are two general categories of stock options with regards to the type and complexity of products being trade namely exotic and vanilla options.

Exotic options refer to a set of more complex products which are usually traded in over-the-counter (OTC) transactions. Exotic options feature distinct callability and putability rights and could involve a set of underlying index and conditions.

On the other hand, vanilla options are exact opposites of exotic options. Vanilla options refer to the general types of stock options. These options refer to regular products and are dealt and transacted in a simpler manner compared to exotic options.

Depending on the nature of the transaction and the overall condition of the stock market, exotic and vanilla options possess unique and distinct advantages over each other. There are glaring differences between exotic and vanilla options which will prove crucial when it comes to their viability and profit potential.

Investors looking for a steadier and safer stock option may consider vanilla options as such options are specific when it comes to the maturity date, payout price and the structure of payment. Needless to say, an exotic option involves greater risk due to some agreed conditions that may rise to varying dates and prices.

Exotic options are tailored according to the specifications of investors and agreements between the buying and selling parties. Moreover, it arises to more complex and sophisticated nature of the option. Conversely, vanilla options are standard options and are sometimes called as pure vanilla options owing to the simplicity of the transaction and nature of the stock option.

Exotic options are also more popular in foreign exchange markets that is why its prices may vary based on external factors, possibly factors relating to foreign countries such as the current political and social conditions in that country. Theoretically, buying vanilla options is advisable when the vesting period is pegged on a short-term period in order to avoid extremely high market fluctuations. 

On the contrary, investors looking for higher gains should examine the structure of exotic options. Thus, such structures can be tailored based on an investor’s needs and specifications that is of course if the selling party agrees with such conditions.