It sleeps until a level's hit:then knocks in, and you hold it.
A type of barrier option that comes into force only if the underlying price reaches a specified level, the barrier, during the option’s life.
Until the barrier is reached the option cannot be exercised, although it still has a market price that reflects the chance of activation.
In plain words
An option is a contract that gives its holder the right, but not the obligation, to buy or sell something at a set price called the strike. A knock-in option is one that comes into force only if the underlying price touches a chosen level, called the barrier, during the option’s life.
See it move
Underlying price has crossed Barrier: Option activates
Why it matters
Barrier options usually cost less than an ordinary option with the same terms, because there are outcomes in which they never come into force. The buyer pays the price of the option, called the premium, at the start, whether or not the barrier is ever touched.
Worked example
An example only. The figures are round and invented for the arithmetic: they are not market prices.
A buyer pays a premium of 100 for a knock-in call, the right to buy, with a strike of 1.2000 and a barrier above it at 1.2200.
- 1Case 1the price reaches 1.2200 during the option’s life, so the option is activated and from then on behaves like an ordinary call
- 2Case 2the price rises only as far as 1.2150, so the barrier is never touched
- 3In case 2 the option never comes into force, although the price finished above the strike
In the second case the buyer has paid 100 and holds nothing, where an ordinary call with the same strike would have had value.
A common mistake
Before the barrier is touched the option is not without a market price: its price reflects the chance that it is activated. What it lacks until then is any right that can be exercised.
Check yourself
Educational information, not investment advice or a recommendation to trade.