Up-and-In Options: Unveiling the Hidden Potential in High-End Investments
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 Insights
- 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.
Image by Julie Bang © Investopedia
Mastering the Mechanism of Up-and-In Options
Up-and-in options are a type of exotic option known as a barrier option. These sophisticated instruments have more complex terms than standard options and can be either knock-in or knock-out variants. The option pays out differently depending on the variety, and may also include a rebate provision if the option is non-exercisable.
Because exotic options are often available in OTC markets, their terms can vary significantly based on the underlying asset’s liquidity, such as forex or stocks. These bespoke options are rarely accessible to most retail investors. Here’s how the payouts vary between the two types.
Knock-In Options
Knock-in options can be either up-and-in or down-and-in, indicating whether the price will rise or fall to meet the barrier level. When the designated barrier price is breached, the option becomes exercisable. An up-and-in option allows exercise when the barrier price level is reached or exceeded. Conversely, a down-and-in option allows exercise when the underlying asset’s price falls to or below a certain level. These options involve either puts or calls. An up-and-in call option benefits the investor when the price rises, while a down-and-in put option benefits when the price falls below the barrier level.
Knock-Out Options
Opposite to knock-in options, knock-out options become non-exercisable when a price barrier is hit. They can be either up-and-out or down-and-out. In an up-and-out option, the product becomes defective when the price reaches or exceeds the barrier. In a down-and-out option, the option becomes defective when the price reaches or falls below the barrier level.
Rebate Barrier Options
Both knock-in and knock-out options can include a rebate provision. These options, known as rebate barrier options, provide a rebate to the holder if the option becomes non-exercisable upon expiration.
Diverse Provisions in Barrier Options
Barrier options can be tailored in various ways. They may include one or multiple touch provisions and may also involve multiple barriers. Some options are effective or defective when a specific barrier price is reached, while others require the underlying security’s price to cross the barrier to incur the option’s provisions.
Embarking on the journey of understanding and utilizing barrier options, especially up-and-in options, can significantly broaden the horizon of sophisticated investment strategies. Whether through institutional avenues or specialized brokers, these intricate financial instruments offer unique opportunities aligned with specific market scenarios.
Related Terms: Knock-in options, Knock-out options, Rebate barrier options, Exotic options, Call options, Put options.
