Barrier Options

From MarketPunter

Barrier options are path-dependent options which come in many flavors and forms, but their key characteristic is that these types of options are either initiated or exterminated upon reaching a certain barrier level; that is, they are either knocked in or knocked out. Barrier options are path-dependent options which come in many flavours and forms, but their key characteristic is that these types of options are either initiated or exterminated upon reaching a certain barrier level; that is, they are either knocked in or knocked out.

Having mentioned that barriers come in all shapes and sizes, we consider the most basic type of barrier option - the single barrier.

This option comes in 8 flavours, each with its own characteristics, which we outline below:

Types:

1. Up & In 2. Up & Out 3. Down & In 4. Down & Out

Where each type can take the form of a call or a put, giving us a total of 8 single barrier types. An "In" barrier means that a barrier becomes active once crossing a particular barrier level; for example, an Up & In barrier becomes active when the underlying price hits a barrier from below.

Barriers also come in various other forms including double barriers, parisians, and partial time barriers, which can all eventually be found in their respective pages. Here, we discuss the various methods of pricing single barriers.

Barriers can take either American or European forms, and despite its seemingly complex payoffs, they are widely used in the markets and are generally cheaper than plain vanilla type options.