A knock-out option is a type of exotic option that becomes void if the underlying asset's price reaches or exceeds a predetermined price level. The predetermined price level is known as the knock-out price.
If the knock-out price is reached or exceeded at any time during the life of the option, the option is immediately void and the investor loses the entire premium that was paid for the option.
Knock-out options are typically used as a way to protect against large losses in the underlying asset. For example, an investor might purchase a knock-out option on a stock that they believe is overvalued and at risk of a sharp decline.
If the stock's price does indeed decline, the investor will be protected from any further losses. However, if the stock's price rises and reaches the knock-out price, the option will be void and the investor will have lost the entire premium.
What is vanilla option?
A vanilla option is a type of options contract that gives the holder the right to buy or sell an underlying asset at a fixed price, known as the strike price, on or before a specified expiration date.
Vanilla options are the simplest and most common type of options contract. They are typically traded on major exchanges, such as the Chicago Board Options Exchange (CBOE), and can be bought and sold through most online brokerages.
The key distinction between a vanilla option and other types of options contracts, such as exotic options, is that vanilla options have standardized terms and are traded on regulated exchanges. This makes them more liquid and easier to price than exotic options.
Vanilla options can be used to speculate on the future direction of an underlying asset, or to hedge against downside risk. For example, a trader who is bullish on the U.S. dollar may buy a vanilla call option on the USD/JPY currency pair, betting that the dollar will rise against the yen. Or, a company that is exposed to currency risk may buy a vanilla call option as a hedge against a decline in the value of the dollar.
There are two types of vanilla options: call options and put options. A call option gives the holder the right to buy an underlying asset at a fixed price, while a put option gives the holder the right to sell an underlying asset at a fixed price.
The price of a vanilla option is determined by a number of factors, including the price of the underlying asset, the strike price, the volatility of the underlying asset, the time to expiration, and the interest rate.
What type of options are knock out and knock in options?
There are two types of options: knock out and knock in options.
Knock out options are options that become void if the underlying asset price reaches a certain level. For example, a knock out option on a stock might become void if the stock price goes above $100.
Knock in options are options that only become active if the underlying asset price reaches a certain level. For example, a knock in option on a stock might only become active if the stock price goes above $100.
Why are barrier options cheaper? There are a few reasons why barrier options are cheaper than regular options. First, barrier options are typically less liquid than regular options, so there is less demand for them. Second, barrier options are often less well-understood than regular options, so there is less demand from sophisticated investors. Finally, barrier options often have more complex payoff structures than regular options, which makes them more difficult to value.
What is a double no touch option?
A double no touch option is a type of exotic option that gives the holder the right to receive a payoff if the underlying asset price does not reach or exceed either of two predetermined barrier levels during the life of the option. The option expires worthless if either barrier is breached.
The double no touch option is similar to a single no touch option, except that there are two barrier levels instead of just one. The double no touch option is also sometimes referred to as a double knock out option or a double barrier option.
The double no touch option is a relatively uncommon option type, and it can be difficult to find market makers who are willing to quote prices for this type of option. The payoff for a double no touch option is also generally less than that of a comparable single no touch option, since the probability of the underlying asset price not touching either barrier is generally lower than the probability of it not touching a single barrier.
How does a knock-in option work? A knock-in option is an option that only becomes active, or "in the money", when the underlying asset reaches a certain price. This price is called the knock-in price. If the underlying asset never reaches the knock-in price, the option will never be active and will expire worthless.
Knock-in options are often used as a way to reduce the cost of an option. For example, a knock-in call option might have a lower premium than a regular call option because the knock-in feature reduces the likelihood that the option will ever be active.
Knock-in options can be used in a variety of different strategies, including hedging, speculation, and income generation.