Knockout Options

A Knockout Option is a barrier option that will become worthless if the market reaches a specific price – known as a barrier level. At this point, the options contract is ‘knocked out’ and there would be no payoff.

If the position isn’t knocked out, it functions like a typical options contract, in which the holder has the right to buy or sell an asset by an expiration date at a certain price.

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Up-and-out vs down-and-out Knockout Options

There are two main types of Knockout Options: up-and-out options and down-and-out options.

An up-and-out Knockout will give the holder the right to buy or sell an underlying asset at a specific strike price if it doesn’t exceed the price barrier during the option’s lifetime. It gets knocked out if the cost of the underlying asset moves above the barrier.

Whereas a down-and-out option gives the owner the right, but not the obligation, to buy or sell an underlying asset at a pre-set strike price, but only if the underlying asset’s price doesn’t fall below the specific barrier during the option’s life.

If the underlying asset price falls below the barrier during the option’s life, the option expires and becomes worthless.

The investor loses the premium they paid for the option, but nothing else.

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