BROWSE

Knock-Out Option

What is a 'Knock-Out Option'

A knock-out option is an option with a built-in mechanism to expire worthless if a specified price level is exceeded. A knock-out option sets a cap to the level an option can reach in the holder's favor. As knock-out options limit the profit potential for the option buyer, they can be purchased for a smaller premium than an equivalent option without a knock-out stipulation.

Explaining 'Knock-Out Option'

A knock-out option is a type of barrier option and may be traded on the over-the-counter market. Barrier options are typically classified as either knock-out or knock-in. A knock-out option ceases to exist if the underlying asset reaches a certain predetermined barrier during its life. Contrary to a knock-out option, a knock-in option only comes into existence if the underlying asset reaches a predetermined barrier price.

Types of Knock-Out Options

A down-and-out option is a type of knock-out option. A down-and-out barrier option gives the holder the right, but not the obligation, to purchase or sell an underlying asset at a predetermined strike price if the underlying asset's price did not go below a specified barrier during the option's life. If the underlying asset's price falls below the barrier at any point in the option's life, the option ceases to exist and is worthless. For example, assume an investor purchases a down-and-out call option on a stock that is trading at $60 with a strike price of $55 and a barrier of $50. Assume the stock trades below $50 before the call option expires. Therefore, the down-and-out call option ceases to exist.


Further Reading


Pricing Lookback Options with Knock‐out Boundaries
www.tandfonline.com [PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …

One-touch double barrier binary option valuesOne-touch double barrier binary option values
www.tandfonline.com [PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …

DOUBLE KNOCK-OUT CALL OPTION PRICING MODEL <span style=[J]' src='/thumbnails/?img=http%3A%2F%2Fen.cnki.com.cn%2FArticle_en%2FCJFDTotal-JJSX200304006.htm' />DOUBLE KNOCK-OUT CALL OPTION PRICING MODEL [J]
en.cnki.com.cn [[J]' href='https:/api.miniature.io/pdf?url=en.cnki.com.cn%2FArticle_en%2FCJFDTotal-JJSX200304006.htm'>PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …

Risk Management Lessons from 'Knock‐in Knock‐out'Option DisasterRisk Management Lessons from 'Knock‐in Knock‐out'Option Disaster
onlinelibrary.wiley.com [PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …

A new approach to pricing double-barrier options with arbitrary payoffs and exponential boundariesA new approach to pricing double-barrier options with arbitrary payoffs and exponential boundaries
www.tandfonline.com [PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …

THE MARTINGLE PRICING METHOD ABOUT A EUROPEAN UP & OUT CALL ON CALL OPTION <span style=[J]' src='/thumbnails/?img=http%3A%2F%2Fen.cnki.com.cn%2FArticle_en%2FCJFDTotal-JJSX200304004.htm' />THE MARTINGLE PRICING METHOD ABOUT A EUROPEAN UP & OUT CALL ON CALL OPTION [J]
en.cnki.com.cn [[J]' href='https:/api.miniature.io/pdf?url=en.cnki.com.cn%2FArticle_en%2FCJFDTotal-JJSX200304004.htm'>PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …

Proposal of a new guaranteed certificate using exotic optionsProposal of a new guaranteed certificate using exotic options
www.ceeol.com [PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …

Early exercise boundaries for American-style knock-out optionsEarly exercise boundaries for American-style knock-out options
www.sciencedirect.com [PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …

Pricing double barrier options using Laplace transformsPricing double barrier options using Laplace transforms
link.springer.com [PDF]
… Abstract. In the last decade, many kinds of exotic options have been traded and introduced in the financial market. This paper describes a new kind of exotic option, lookback options with knock‐out boundaries …



Q&A About Knock-Out Option


What does a European call option behave like?

A European call option behaves in every way like a vanilla European call except if the spot price ever moves above 12, the option "knocks out" and the contract is null and void.

How do you know if your call or put options are in danger of being knocked out?

You can check the market value of your options on any given day. If they are trading at less than their strike price, then they may be in danger of being knocked out.

How do you compensate for a knock-out by paying cash fraction of premium at time of breach?

You can pay cash fraction of premium at time of breach.

What are the four main types of barrier options?

The four main types of barrier options are in-out, up-down, knock-in and knock-out.

What does the term "down and out" mean?

The term down and out means that the stock's price has fallen below the barrier.

What happens if your down and out call or put options get knocked out before expiration date?

Your contract will expire worthless, meaning that you lose all of your investment in it.

When would you use a down and out option?

Down and out options can be used when you want to protect yourself from downside risk but don't want to spend too much money on insurance. They are also useful for hedging against short positions that have already been established.

What is a knock-out option?

A knock-out option is an option with a built-in mechanism to expire worthless if a specified price level is exceeded.