4 types of Barrier Options

Knock-in barrier options

 

KI options are path-dependent options that are activated if a specified spot rate reaches a specified trigger level between the option’s inception and expiry.

 

- the nearer the barrier level to the initial spot --> the more expensive the KI option. 

- the KI option is more sensitive to volatility than a vanilla option (higher vega) carrying the same features. Indeed, a higher volatility increases not only the probability of maturing ITM but also the probability of reaching the barrier and being activated. 

- the higher the number of barrier observations, the more expensive the KI option since the probability of activating it is higher. 

 

Regular KI options --> barrier placed in such a way that the option is activated when it is OTM --> easier for traders to hedge the associated risks. 

Reverse KI options --> barrier placed in such a way that the option is activated when it is ITM --> higher trading difficulty and risks. 

 

 

Up-and-in Call / Up-and-in Put

Up-and-in calls are common. This is because, when the underlying asset increases to KI barrier level, it would most likely stay above the initial level.

Therefore , call options will be more likely ITM at maturity than put options. 

 

Bullish investors can buy UI call options and pay a lower premium than that on the vanilla call options. This makes the UI calls more leveraged than vanilla calls. 

 

Down-and-in Call / Down-and-in Put

Down-and-in puts are common. This is because, when the underlying asset decreases to KI barrier level, it would most likely stay below the initial level.

Therefore , put options will be more likely ITM at maturity than call options. 

 

Bearish investors can buy DI put options and pay a lower premium than that on the vanilla put options. This makes the DI puts more leveraged than vanilla puts. 

Knock-out barrier options

 

KO options are path-dependent options that are terminated if a specified spot’s price reaches a specified trigger level at any time between inception and expiry. In this case, the holder of the option gets zero payout.

 

- the closer the barrier level is to the initial spot --> the cheaper the KO option. 

- the KO option is less sensitive to volatility than a vanilla option (lower vega) carrying the same features. Indeed, a higher volatility increases the probability of reaching the barrier and ending with no value. 

- the higher the number of barrier observations, the cheaper the KO option since the probability of losing it is higher. 

 

Regular KO options --> barrier placed in such a way that the option vanishes when it is OTM --> easier for traders to hedge the associated risks. 

Reverse KO options --> barrier placed in such a way that the option vanishes when it is ITM --> higher trading difficulty and risks. 


 

Up-and-out Call / Up-and-out Put

 

Bearish investors will buy UO put options and pay a lower premium than that on the vanilla put options. This makes the UO puts more leveraged than vanilla puts. 

 

Down-and-out Call / Down-and-out Put

 

Bullish investors will buy DO call options and pay a lower premium than that on the vanilla call options. This makes the DO calls more leveraged than vanilla calls. 

Add a comment