Question Details

	Username: ForexGuy Rating: Asked to: Jun Wang Date Created: 21 Feb 2018
Category	27
Tag	Financial
Question	What is a 'Knock-Out Option'?

Advice from Guru

Hello ForexGuy,

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.

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.
For example, an option writer may write a call option on a $40 stock, with a strike price of $50 and a knock out level of $60. This option only allows the option holder to profit up to $60, at which point the option expires worthless, limiting the loss potential for the option writer. Knock-out options are considered to be exotic options, and they are primarily used for commodities and currency options.

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