Knock In Knock-Out

Definition

A Knock In Knock-Out is a vanilla option that becomes alive if spot crosses the Knock-In barrier first during the life of the option. After being knocked-in, the option may also be knocked-out if the spot crosses the Knock-Out barrier before expiry.

If the spot crosses the Knock-Out barrier first during the life of the option, then the option ceases to exist: It cannot be knocked-in anymore.

Barriers

Barriers can be both above the strike, below the strike, or one above and one below the strike.

Premium

The Knock-In Knock-Out premium is lower than that of a regular vanilla option.

The further away the Knock-In barrier from spot, the lower the premium, as there is lower probability that the option will become alive before expiry.

The closer the Knock-Out barrier to the spot, the lower the premium, as there is higher probability that the option will be knocked-out before expiry.

Payoff

If the option is knocked-in and it is not knocked-out, then the profile of a Knock-In Knock-Out option is the same as with a regular vanilla option.

If the option is knocked-out or if it is not knocked-in, the customer having a position in the underlying currency does not benefit from any FX hedge.