What is a Knock-In Option?

What is a Knock-In Option?

A knock-in option is a latent option contract that begins to function as a normal option (“knocks in”) only once a certain price level is reached before expiration. Knock-ins are a type of barrier option that are classified as either a down-and-in or an up-and-in.

A barrier option is a type of contract in which the payoff depends on the underlying security’s price and whether it hits a certain price within a specified period.

introduction of Knock-In Options

Knock-in options are one of the two main types of barrier options, with the other type being knock-out options.

A knock-in option is a type of contract that is not an option until a certain price is met. So if the price is never reached, it is as if the contract never existed. However, if the underlying asset reaches a specified barrier, the knock-in option comes into existence.

The difference between a knock-in and knock-out option is that a knock-in option comes into existence only when the underlying security reaches a barrier, while a knock-out option ceases to exist when the underlying security reaches a barrier. Understanding Knock-In Options

Knock-in options are one of the two main types of barrier options, with the other type being knock-out options.

A knock-in option is a type of contract that is not an option until a certain price is met. So if the price is never reached, it is as if the contract never existed. However, if the underlying asset reaches a specified barrier, the knock-in option comes into existence.

The difference between a knock-in and knock-out option is that a knock-in option comes into existence only when the underlying security reaches a barrier, while a knock-out option ceases to exist when the underlying security reaches a barrier.

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Types of Knock-In Options

1. Down-and-In Knock-In Option

A down-and-in option occurs when the price of an asset falls to a certain price, which is called the barrier price. The options contract is activated only if the asset’s price goes below the barrier price.

An activated options contract acts like any other option by giving the option holder the right to exercise the option at the strike price before the contract’s expiration date. However, if the asset’s price does not go below the barrier price, then the options contract will not come into existence.

2. Up-and-In Knock-In Option

An up-and-in option occurs when the price of an asset reaches the barrier price, which activates the options contract. If the asset’s price never reaches the barrier price, then the options contract cannot be exercised.

Therefore, an up-and-in call option benefits the investor when the asset’s price is rising. On the other hand, a down-and-in put option benefits the investor when the asset’s price is falling.

Knock-in option – example

You may, for example, buy a knock-in option to purchase a share of stock for a strike price of $20 which knocks in

If the price of the stock does not reach $30 over the option’s life, it’s as if it had never existed.

However, if the price of the stock price hits the knock-in price, the option automatically activates. It is subsequently an ordinary option with a $20 strike price.