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Knock-In Option

Knock-In Option

What is a 'Knock-In Option'

A knock-in option is a latent option contract that begins to function as a normal option ("knocks in") only once a certain price level is reached before expiration. Knock-in options are a type of barrier option that may be either down-and-in option or an up-and-in option. A barrier option is a type of contract in which the payoff depends on the underlying security's price and whether it hits a certain price within a specified period.

Explaining 'Knock-In Option'

There are two main types of barrier option: knock-in and knock-out options. Technically, a knock-in option is a type of contract that is not an option until a certain price is met, so if the price is never reached it is as if the contract never existed. However, if the underlying asset reaches a specified barrier, the knock-in option comes into existence. The difference between a knock-in and knock-out option is that a knock-in option comes into existence only when the underlying security reaches a barrier, while a knock-out option ceases to exist when the underlying security reaches a barrier.

Down-and-In Option

For example, assume an investor purchases a down-and-in put option contract with a barrier price of $90 and a strike price of $100, when the underlying security was trading at $110, with three months until expiration. If the price of the underlying security reaches $90, the option comes into existence and becomes a vanilla option with a strike price of $100. Thereafter, the holder of the option has the right to sell the underlying asset at the strike price of $100. The put option remains active until the expiration date, even if the underlying security rebounds from $90. However, if the underlying asset does not fall below the barrier price at any point during the life of the contract, the down-and-in option expires worthless.

Up-and-In Option

Contrary to a down-and-in option, an up-and-in option comes into existence only if the barrier is reached, which is higher than the underlying asset's price. For example, assume a trader purchases a one-month up-and-in call option on an underlying asset when it was trading at $40 per share. The up-and-in call option contract has a strike price of $50 and a barrier of $55. If the underlying asset did not reach $55 at any point during the life of the option contract, it would expire worthless. However, if the underlying asset rose to $55 or greater, the call option would come into existence.


Further Reading

Knock‐in American optionsKnock‐in American options
onlinelibrary.wiley.com [PDF]
… Knock-in options with a trigger clause are closely related to barrier options. Barrier options are common path-dependent options traded in the financial markets. The derivation of the price formula for barrier options was pioneered by Merton (1973) in his seminal paper on option …

Pricing and hedging of American knock-in optionsPricing and hedging of American knock-in options
jod.pm-research.com [PDF]
… Knock-in options with a trigger clause are closely related to barrier options. Barrier options are common path-dependent options traded in the financial markets. The derivation of the price formula for barrier options was pioneered by Merton (1973) in his seminal paper on option …

Static hedging and pricing American knock-in put optionsStatic hedging and pricing American knock-in put options
www.sciencedirect.com [PDF]
… Knock-in options with a trigger clause are closely related to barrier options. Barrier options are common path-dependent options traded in the financial markets. The derivation of the price formula for barrier options was pioneered by Merton (1973) in his seminal paper on option …

One-touch double barrier binary option valuesOne-touch double barrier binary option values
www.tandfonline.com [PDF]
… Knock-in options with a trigger clause are closely related to barrier options. Barrier options are common path-dependent options traded in the financial markets. The derivation of the price formula for barrier options was pioneered by Merton (1973) in his seminal paper on option …

Monte-Carlo importance sampling simulation method for pricing the European knock-in optionMonte-Carlo importance sampling simulation method for pricing the European knock-in option
en.cnki.com.cn [PDF]
… Knock-in options with a trigger clause are closely related to barrier options. Barrier options are common path-dependent options traded in the financial markets. The derivation of the price formula for barrier options was pioneered by Merton (1973) in his seminal paper on option …

Risk Management Lessons from 'Knock‐in Knock‐out'Option DisasterRisk Management Lessons from 'Knock‐in Knock‐out'Option Disaster
onlinelibrary.wiley.com [PDF]
… Knock-in options with a trigger clause are closely related to barrier options. Barrier options are common path-dependent options traded in the financial markets. The derivation of the price formula for barrier options was pioneered by Merton (1973) in his seminal paper on option …

Pricing double barrier options using Laplace transformsPricing double barrier options using Laplace transforms
link.springer.com [PDF]
… Knock-in options with a trigger clause are closely related to barrier options. Barrier options are common path-dependent options traded in the financial markets. The derivation of the price formula for barrier options was pioneered by Merton (1973) in his seminal paper on option …

Pricing Parisan OptionsPricing Parisan Options
jod.pm-research.com [PDF]
… Knock-in options with a trigger clause are closely related to barrier options. Barrier options are common path-dependent options traded in the financial markets. The derivation of the price formula for barrier options was pioneered by Merton (1973) in his seminal paper on option …


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