What Is an Up-and-In Option?
Up-and-in options are a type of exotic option that is often made available through specialized brokers to high-end clients in the over-the-counter (OTC) markets. The option features both a strike price and a barrier level. As the name suggests, the buyer of the option will benefit once the price of the underlying rises high enough to reach (knock-in) the designated barrier price level. Otherwise, the option will expire worthless.
Key Takeaways
- These are exotic options usually available to institutional investors on stocks or forex.
- These options have both a strike price and a barrier level specified.
- An up-and-in option pays out when the underlying reaches the barrier price level before expiration.
How an Up-and-In Option Works
Up-and-in options are a type of exotic option known as a barrier option. As an exotic option, barrier options are structured with more complex terms than standard plain vanilla options. Barrier options can be of two varieties, either a knock-in option or a knock-out option. The option pays out differently depending on the variety. Barrier options may also include a rebate provision for the holder if the option cannot be exercised.
Because exotic options are often available in OTC markets, there is a fair amount of variation in how these options may be offered. Depending on the liquidity of the underlying, which may be forex or stocks, some options may be offered in a bespoke manner. These kinds of options are also rarely available to most retail investors. Here is how the payouts vary between the two varieties.
Knock-In Options
Knock-in options can be either up-and-in or down-and-in. This implies whether the price will rise or fall to meet the barrier price level. The barrier price, when crossed, makes the option available for exercise. An up-and-in option will give the holder the right to exercise when the barrier price level is reached or exceeded, depending on the structuring.
In a down-and-in option, the holder gets the right to exercise when the underlying asset’s price falls to, or below, a certain barrier level. Barrier options are structured with either puts or calls. An up-and-in call option allows an investor to benefit when a price is rising. A down-and-in uses a put option and allows an investor to benefit when a price is falling.
Knock-Out Options
Knock-out options are the opposite of knock-in options. These products make the option defective when a price is reached, but viable so long as the barrier price is not reached. Knock-out options can be either up-and-out or down-and-out. With an up-and-out option, the product becomes defective when a price is reached or exceeded, and with a down-and-out option, the product becomes defective when a price falls to or below its barrier level.
Rebate Barrier Options
Both knock-in and knock-out options can include a rebate provision. These options will be known as rebate barrier options. In a rebate barrier option, the holder receives a rebate when the option is non-exercisable at expiration.
Barrier Option Provisions
Barrier options can be structured in various ways. These options are American options with a flexible exercise date. Some options may become effective or defective when a specific barrier price is reached while others require the security’s value to move through the price before their provisions are enacted.
Barrier options can also include modified touch provisions. Some barrier options may include one touch while others require multiple touches. Barrier options can also be structured to include provisions for two or more barriers.
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