The last decades have witnessed a steady growth in financial risk. This process has contributed to a rapid development of financial derivatives. The introduction of exotic options into the market has marked a subsequent stage in that process. These instruments enjoy an unusual demand among investors because they offer far greater opportunities than standard derivatives. In Poland there is still a relatively small number of such derivatives that can be traded. Only trade in foreign currency options has developed until now. The problems of development of trade in those instruments result primarily from the inability to appropriately assess risk using available computer software, and from difficulties in appropriate valuation of those instruments. The paper discusses the principles of valuation for selected exotic options.

Numerous banks worldwide develop hedging strategies, applying various kinds of exotic options, valuate those instruments and trade in them. They are defined as optional contracts, which guarantee a different composition of return than standard put and call options. They tend to be referred to as derivative instruments of the second generation.

The introduction of those instruments was a response of the above mentioned financial institutions to the demand of the market. Exotic options are not a new instrument in financial markets. Some of them were launched as long ago as a few years before the establishment of an official exchange, where trading in options was carried out, i.e. the Chicago Board of Options Exchange (CBOE). Enterprises, in order to limit their exposure to risk, had to hedge their positions in the derivative instruments market. Moreover, more volatile prices of numerous assets created extensive opportunities to make earnings. This contributed to the development of demand for those instruments.

The majority of exotic options are traded on the OTC (Over the Counter) market (principally on the interbank market) although some of them are traded on the stock exchange - for instance, spread options are traded on the New York Mercantile Exchange (NYMEX). But trade in them is only a small fraction of the overall volume of trade in exotic options. Due to poor transparency of the OTC market those instruments remain to be exotic for many investors, even for those, who are fully familiar with trading in standard options. Although most derivatives are traded on controlled markets, exotic options stand exception to this. This results from their unique character, which makes it impossible to standardise the product and introduce it into trade on the stock exchange. In contrast to the derivatives traded on the stock exchange, exotic options may be freely tailored to investors' needs.

Further development of exotic options both in Poland and abroad should be preceded by their active popularisation by banks involved in trading them and encouraging exporters and importers to use those financial instruments and rationally manage risk with their help.