What exactly are exotic equity derivatives?

exotic just means that there are some very specific rules for how the claim works. As opposed to a call or put option which are fairly straight forward. Any way you can think of for determining the payoff of a derivative claim has probably been thought of and tried before you. And the answer to you question? how would an investor make money off something like this? in your case, you wouldn't. You'd lose all your money. Remember, the vast majority of derivative activity is due to hedging, not speculating. There are only a very few people that a) really understand derivatives investing and b) granting that specialized knowledge, are perceptive enough to conceive of a market trend, come up with a trading idea to capitalize on it, and then actually be right.

Asian · Barrier · Binary · Cliquet · Compound option · Forward start option · Lookback · Mountain range · Rainbow option, etc.... start on wikipedia

untilted is correct here, but the larger idea is that the person who is coming up with the idea in the first place is usually doing it to achieve some customized hedge to a particular exposure. Only very very few people are skilled enough to engage in pure speculation in this sort of thing and then actually make money.

^^^correct me if im wrong......but basically you would be long on a stock/bond/etc..... and u would hedge ur exposure ...using exotic derivatives ?........also where do you see the market for exotic derivatives going in the future?

You could be long or short, it doesn't matter. They are customizable to the risk companies have. They also allow hedge funds who have specific ideas to take bets on them. For example, a hedge fund that wants to bet that a security will increase but not beyond a certain point might buy an RKO. Because the RKO can disappear if it hits the trigger (trigger> strike), it is cheaper, which allows the fund to have a more leveraged bet. This is one example of a non-hedge situation.

What is this rainbow option???? are they pots of gold traded by filipinos or what

use words, son. Are you sure you aren't talking about exotic dancers? Where do I see them going? Nowhere, they're going to stay exactly where they are now. The people buying the more complicated claims usually have huge asset bases with very unique exposures - and they try their best to hedge them with whatever a market maker is willing to sell them. Finding a willing market maker is not a trivial point as it provides the upper bound on how crazy you can get, after all, any position you take, he takes the opposite - not a lot of fun for the mkt mak if it leaves him unhedged. At the end of the day, though, we're not talking about some day trader in dirty shorts who owns stock and then for the pure fun of it tries to buy a crazy option to "hedge" his exposure. Why are you asking these ridiculous questions?

one of the main reasons that exotics exist is that they are often cheaper to buy compared to acquiring a portfolio that has the same risk exposure