Here’s the latest question sent in by site visitors who have attended equities interviews at investment banks. This was allegedly asked in an equity trading interview at JPMorgan. If you disagree with the answer at any point, please express your opinion in the comments box below.
THE QUESTION: Explain exotic equity options to an 8 year old in a few lines
The reality is that there is no real good answer to this: by their very nature these instruments are complex and even to get on to the matter you would have to explain basic optionality first.
The best way to approach it is to drastically simplify everything and give some sort of tangible examples.
For instance: Equity options are like a game where your parents tell you that if it doesn’t rain all week you can eat cake on Sundayif you want (the value of the game is determined or derived by some event and you have the option to participate in the upside but you don’t have to, i.e. you have the option).
Exotic equity options are like your parents saying if it rains on a day of the week that starts with T, you can eat one cake, if its sunny for three days you can eat two more cakes and if it snows, the game ends immediately, they are basically much more complex games (alluding to the greater number of clauses, rebates and knock in/out potential).