Barrier options are path-dependent exotics that are identical in some ways to ordinary options. There are put and call, as well as there are some European and American varieties. But if the underlier reaches a predetermined level (barrier) then they become activated or, on the contrary, null and void.
“In” Options
“In” options lives are started as worthless and they only become active in the event a predetermined knock-in barrier price is breached.
“Out” Options
“Out” options lives are started as active and they become null and void in the event a certain knock-out barrier price is breached.
In any of the above two cases, if the option expires when it is inactive, then there might be a cash rebate paid out. In case if the option ends up worthless then this could be nothing, or it could be some fraction of the premium.
Main types of Barrier Options
Following are the four main types of barrier options:
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Up-and-out: In this type of barrier option, spot price starts below the barrier level and it has to move up for the option to be knocked out.
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Down-and-out: In this type of barrier option, spot price starts above the barrier level and it has to move down for the option to become null and void.
