In finance, a barrier option is an exotic derivative typically an option on the underlying asset whose price breaching the pre-set barrier level either springs the option into existence or extinguishes an already existing option.
- Where the option springs into existence on the price of the underlying asset breaching a barrier, it may be known as an "up and in," "knock-in," or "down and in" option.
- Where the option is extinguished on the price of the underlying asset breaching a barrier, it may be known as an "up and out," "knock-out," or "down and out" option.
Barrier options are always cheaper than a similar option without barrier. Thus, barrier options were created to provide the insurance value of an option without charging as much premium. For example, if you believe that IBM will go up this year, but are willing to bet that it won't go above $200, then you can buy the barrier and pay less premium than the vanilla option.
Read more about Barrier Option: Types, Barrier Events, Variations, Valuation
Famous quotes containing the words barrier and/or option:
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“Our passional nature not only lawfully may, but must, decide an option between propositions, whenever it is a genuine option that cannot by its nature be decided on intellectual grounds; for to say, under such circumstances, “Do not decide, but leave the question open,” is itself a passional decision—just like deciding yes or no—and is attended with the same risk of losing the truth.”
—William James (1842–1910)