What Are Mountain Range Options?
What is an option?
An option contract is a derivative contract that derives its value from the underlying asset. It provides its buyer the right to buy or sell the underlying asset at a specific price for a certain duration. The right to buy or sell can be exercised by the buyer at his/her discretion within the duration of the contract. The buyer has no obligation to exercise the option. However, the seller is under obligation to abide by the contract, should the buyer choose to exercise his/her option. After the duration stipulated in the option contract is over and the option isn't exercised before it, then it has no value as each option contract has an expiration date.
What are exotic options?
Exotic option contracts are option contracts that are different from the standardized option contracts otherwise available in the market with regards to payment structures, duration, expiration dates, strike prices etc
What are basket options?
A basket option is an exotic option wherein the underlying asset is essentially a grouping or basket of an asset, such as commodities, stocks, securities, or currencies.The weighted value of the constituents of the basket determine the strike price of a basket option.
What are Range options?
A range option is a binary option wherein an investor indicates a set range in which he/she thinks that the asset price will fluctuate within up to the moment when the option expires according to his/her analysis. If the forecast holds true, then he/she can receive up to 100% of initially invested funds as profit.
What are mountain range options?
Mountain range options are exotic options that have the combined features of range options and basket options. These are active for a specified time and the payoff is dependent on the performances of multiple underlying assets.
These options were originally marketed by a French organization Société Générale in 1998.
Salient features of mountain range options:
Mountain range options are customized according to the needs of the buyer and seller.
Mountain range options are traded Over-the-counter (OTC) which is why they are not as liquid as standardized options traded on exchanges. They are traded primarily by private banks and institutional investors.
Named after mountain ranges
Mountain range options are easy to identify as they are named after mountain ranges.
Benefits of investing in Mountain range options
Mountain range options promote efficiency by allowing the investor to hedge the risk as the payoff is dependent on the movement of multiple securities.
Mountain range options are customisable to accommodate the needs of both the buyer and the seller.
Drawbacks of investing in Mountain range options
Each mountain range option is tailor-made according to suit the needs of the counterparties involved and traded over-the-counter. It is difficult to exit such positions before expiry as finding another party to offset their current position can be difficult. This restricts liquidity, thus blocking the capital deployed.
Some mountain range options are long term contracts with the duration of 10-15 years. Investing in one position for such a long period, leads to inefficiency in capital deployment, thus resulting in opportunity cost for the investor as he/she cannot deploy the same funds elsewhere.
Also as some of the mountain range options have deductive baskets that remove constituents over a period of time, this too is a missed opportunity at times as the constituents may perform better after being removed, but the investor will not benefit from the momentum.
Examples of Mountain range options
- Annapurna option: In Annapurna options, the buyer has a bullish view and receives a payoff if all the constituents from the underlying basket of securities stay above the predetermined fraction of the initial value till maturity.
- Atlas option: In an Atlas option, some of the best and worst performing stocks are removed from the basket of underlying assets/ securities at pre-specified intervals leading up to maturity. The payoff is similar to that of a call option on the remaining underlying securities basket at maturity.
- Everest option: In an Everest option the underlying basket contains a large number of securities (10-25). It is a long term option with the duration of 10-15 years. The payoff of the buyer is essentially dependent on the worst-performing constituent security of a large basket at maturity.
- Himalayan option: The Himalayan option is essentially a call option based on the average performance of the best performing securities within the basket. On every observation date, the return level of the best performing security is locked in after which it is trimmed off from the basket. At maturity when only one stock remains, the return level of the remaining security is locked in for payoff calculation.The Himalayan option's total payout is the aggregate total of all the interim locked-in return levels.