Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Courses
  • Find a Job
  • Tutoring
  • Home
  • Economics, Finance, & Analytics
  • Investments, Trading, and Financial Markets

Knock Out Option - Explained

What is a Knock Out Option?

Written by Jason Gordon

Updated at April 17th, 2022

Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Marketing, Advertising, Sales & PR
    Principles of Marketing Sales Advertising Public Relations SEO, Social Media, Direct Marketing
  • Accounting, Taxation, and Reporting
    Managerial & Financial Accounting & Reporting Business Taxation
  • Professionalism & Career Development
  • Law, Transactions, & Risk Management
    Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
  • Business Management & Operations
    Operations, Project, & Supply Chain Management Strategy, Entrepreneurship, & Innovation Business Ethics & Social Responsibility Global Business, International Law & Relations Business Communications & Negotiation Management, Leadership, & Organizational Behavior
  • Economics, Finance, & Analytics
    Economic Analysis & Monetary Policy Research, Quantitative Analysis, & Decision Science Investments, Trading, and Financial Markets Banking, Lending, and Credit Industry Business Finance, Personal Finance, and Valuation Principles
  • Courses
+ More

Table of Contents

What is a Knock-Out Option?How Does a Knock-Out Option Work?Types of Knock-Out OptionsReasons These Options Are Used

What is a Knock-Out Option?

A knock-out option is an option contract that will automatically expire even before the set expiration date arrives when a specified price level of underlying asset is reached. This option sets a cap on the price level a contract option can reach to ensure that a price disadvantageous to the option writer is not reached. Knockouts will end up with the option holder losing the premium, which are normally cheaper than in other options, but some knock-out options refund the lost premiums.

Back to:INVESTMENTS & TRADING

How Does a Knock-Out Option Work?

Knock-out options come as barrier options traded on OTC markets. Barrier options can either be knock-out or knock-in options. Knock-out options will expire when a predetermined price is reached while knock-in options will start existing when a predetermined price level is arrived at. Suppose an option writer writes a contract option on a $60 stock with a $70 strike price and a $80 knock-out level. In such a case, the option holders profits are up to $80. At $80, the option expires. These options are common in Forex markets.

Types of Knock-Out Options

There are two types of knock-out options; a down-and-out and up-and-out options. Down-and-out options give the holder the right to buy or sell an asset at a specified strike price if the price of the asset goes below a predetermined barrier. Whenever the price of the asset goes below the set barrier, the option expires. Suppose an option writer writes a down-and-out option for a stock trading at $80 with a strike price of $75 and a barrier set at $70. If the price of the asset falls to $70 before the option expires, the down-and-out option will cease to exist. Up-and-out options lets the holder purchase or sell an asset at a given strike price if the price of the asset does not exceed the specified barrier before it expires. If the price of the asset increases above the barrier, the up-and-out option ceases to exist.

Reasons These Options Are Used

Knock-out options are preferred by investors because their premiums are cheaper and therefore less risky. Investors are sure that they will not be completely knocked out of trade. The options are also used by institutions that only need to hedge up or down to a specified price level.

knock out option

Was this article helpful?

Yes
No

Related Articles

  • Underwater (Value of Asset) - Explained
  • Daily Trading Limit (Securities) - Explained
  • Bowie Bond - Explained
  • Put (Option Contract) - Explained



©2011-2023. The Business Professor, LLC.
  • Privacy

  • Questions

Definition by Author

0
0
Expand