Overview

Market participants are aware of the benefits of using options in their hedging and investing activities, but, when buying options, they are resistant to shelling-out cash on an instrument that may ultimately have no value. Barrier options can help in this regard.

The most common forms of barrier option are simple ‘knock-in’ or knock-out’ structures where an option either comes into existence (or else is extinguished) if the price of some reference asset moves above or below a ‘barrier’ level. Since the existence of the barrier always reduces the possibility of exercise, the barrier option will be cheaper than a vanilla call or put. However, the pricing and trading of these instruments can be far from straightforward. This tutorial describes the different forms of barrier option, how they are used, and how they are priced and managed.

Objective

On completion of this tutorial, you will be able to:

- Describe the key features and types of barrier option
- Explain why barrier options are useful
- Outline the pricing mechanisms for barrier options
- Describe how and when the sensitivities of these instruments differ from 'vanilla' alternatives

Content

Topic 1: Introduction to Barrier Options
Topic 2: Using Barrier Options
Topic 3: Risks of Barrier Options
Topic 4: Pricing Barrier Options