Fx options knock in
The payoff therefore is the difference between the average price of the underlying asset, over the life of the option, and the exercise price of the option. Barrier Options - These are options that have an embedded price level, barrier , which if reached will either create a vanilla option or eliminate the existance of a vanilla option. The existance of predetermined price barriers in an option make the probability of pay off all the more difficult. Thus the reason a buyer purchases a barrier option is for the decreased cost and therefore increased leverage.
Basket Options - This type of option allows the buyer to combine two or more currencies and to assign a weight to each currency. The payoff is determined by the difference between a predetermined strike price and the combined weighted level of the basket of currencies chosen at the outset.
The USDX futures contract can be considered as a basket of currencies, with each currency assigned a particular weight. In the otc market, however, the buyer chooses the currencies and the weight distribution. Bermuda Options - This is a type of option that is exercisable only on predetermined dates, such as every month, or every quarter. They are neither american style or european style, hence the term, "bermuda". Chooser Options - Allows the buyer to determine the characteristics of an option during a predetermined set time span.
As an example, during a 30 day period, the buyer can determine if the option will be a put or call, what the strike price will be, and at times even set the expiry date.
After the 30 day period has elapsed, the seller must enter into an option agreement with the buyer according to the terms chosen by him. This type of option is generally quite expensive because of the flexibility afforded to the buyer.
Chapter European Barrier Options - FX Derivatives Trader School [Book]
Compound Options - This is simply an option on an existing option. Deferred Payment Options - This type of option is simply an american style vanilla option with a "twist". The buyer may exercise at any time, however, payment is deferred until the original expiry date.
This type of option is less expensive than your standard american style vanilla option. It is also a longer term option with expiry dates normally not less than a year out. The "one touch" digital provides an immediate payoff if the currency hits your selected price barrier chosen at outset. The "double no touch" provides a payoff upon expiration if the currency does not touch both the upper and lower price barriers selected at the outset. It is referred to as "all or nothing" because even if your option finishes in the money by 1 pip, you receive the full payoff.
Digital options are usually settled in cash. Dual-Factor Barrier Options - This currency option has a predetermined barrier set in a different underlying market. It is often used in hedging commodity price movements. Exotic Options - This is a term used to categorize options that are not vanilla options, but rather those very options listed here.
There are many other variations of exotic options than those listed in this glossary, with more being invented all of the time.
This list, however, does cover the more common exotic options. Knockin Options - There are two kinds of knock-in options, i up and in, and ii down and in. With knock-in options, the buyer starts out without a vanilla option. If the buyer has selected an upper price barrier, and the currency hits that level, it creates a vanilla option with a maturity date and strike price agreed upon at the outset.
Barrier options are path-dependent exotics that are similar in some ways to ordinary options. You can call or put in American , Bermudan , or European exercise style. But they become activated or extinguished only if the underlying breaches a predetermined level the barrier. Some variants of "Out" options compensate the owner for the knock-out by paying a cash fraction of the premium at the time of the breach.
A barrier event occurs when the underlying crosses the barrier level. While it seems straightforward to define a barrier event as "underlying trades at or above a given level," in reality it's not so simple.
What if the underlying only trades at the level for a single trade? How big would that trade have to be? Would it have to be on an exchange or could it be between private parties?
When barrier options were first introduced to options markets, many banks had legal trouble resulting from a mismatched understanding with their counterparties regarding exactly what constituted a barrier event. Barrier options are sometimes accompanied by a rebate , which is a payoff to the option holder in case of a barrier event.
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Rebates can either be paid at the time of the event or at expiration. Barrier options can have either American , Bermudan or European exercise style.