In Chapter 12, Monte Carlo Simulation, we discussed two exotic options. For convenience, we will include them in this chapter as well. Because of this, readers will find some duplicates. European and American options are path-independent options. This means that an option's payoff depends only on the terminal stock price and strike price. One related issue for path-dependent options is market manipulation at the maturity date. Another issue is that some investors or hedgers might care more about the average price instead of a terminal price.
For example, a refinery is worried about oil, its major raw material, and price movement in the next three months. They plan to hedge the potential price jumps in crude oil. The company could buy a call option. However, since the firm consumes a huge amount of crude oil every day, naturally it cares more about the average price instead of just the terminal price on which a vanilla call option depends. For such cases, average options...