Exotic Options - Barrier Options

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Dave Cleveland

This page is part of the Wikinvest Guide to Options. Related articles within this guide include:

• Exotic Options
• Options Pricing
• Options Strategies

Barrier Options are option contracts whose payoff depends on whether or not the price of the underlying asset crosses a certain level during the option's lifetime. There are four basic types of barrier options that have slightly different payoff structures. These options can all be written as either puts or calls. When barrier options are sold they are created with a specified expiration date, a strike price and a barrier price.

• Down-and-Out Barrier Options: A down-and-out option gives the holder the right but not the obligation to buy (in the case of a call) or sell (in the case of a put) shares of an underlying asset at a pre-determined strike price so long as the price of that asset did not go below a pre-determined barrier during the option lifetime. That is, once the price of the underlying asset falls below the barrier, the option is "knocked-out" and no longer carries any value. Hence the name down-and-out.

• Down-and-In Barrier Options: A down-and-in option is the opposite of a down-and-out barrier option. Down-and-in options only carry value if the price of the underlying asset falls below the barrier during the options lifetime. If the barrier is crossed the holder of the down-and-in option has the right to buy (if it is a call) or sell (if it is a put) shares of the underlying asset at the predetermined strike price on the expiration date.

• Up-and-Out Barrier Options: An up-and-out barrier option is similar to a down-and-out barrier option, the only difference being the placement of the barrier. Rather than being knocked out by falling below the barrier price, up-and-out options are knocked out if the price of the underlying asset rises above the predetermined barrier.

• Up-and-In Barrier Options: An up-and-in barrier option is similar to a down-and-in option, however the barrier is placed above the current price of the underlying asset and the option will only be valid if the price of the underlying asset reaches the barrier before expiration.