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A knock-out option is a type of barrier option that expires worthless if a specific price threshold is crossed by the option’s underlying security. A knock-out option is typically a currency or commodity option. For a knock-out option, the option writer sets the limit, with the aim of restricting his losses in the event of a sharp price move. For example, in a knock-out option, if the current price for gold is $96/oz., the writer offers a $100 call with a $108 knock-out limit. The knock-out option lets the option writer remove exposure to large losses. Correspondingly, an option buyer pays less for a knock-out option because it offers only limited profit opportunity. A knock-out option investor benefits when expected price moves are small. A knock-out option can also be structured with a rebate feature so that when the knock-out level is reached, the buyer will receive a small payout. Any barrier options, including a knock-out option, is activated or de-activated once the price of the underlying financial instrument reaches a set level. The opposite of a knock-out option is a trigger option or knock-in option. |
