Knock-in options definition
A knock-in option is a type of options contract that is not activated until a predetermined price is reached. The knock-in options contract is inactive until that price is reached.
Knock-in options are one example of a barrier option: options contracts with earnings dependent on whether the underlying asset reaches a specific price level, referred to as the barrier price.
In the case of a knock-in option, the barrier price must be achieved or surpassed before the option’s expiration in order to become active. There are two types of knock-in options:
- Down-and-in options, which are activated when the underlying asset’s price dips below the barrier price
- Up-and-in options, which are activated when the asset’s price rises above the barrier price
Knock-in options are mainly used in commodity and currency markets and can be traded over-the-counter. Premiums on these options are usually cheaper than regular options, but buyers run the risk of not realizing any profits if the barrier price is not hit before expiration.
Example of a knock-in option
An investor buys long and purchases a put option for an asset trading at $50, with a strike price of $40, and a barrier price of $30. The asset price must reach $30 before the options contract expires for the investor to sell the underlying asset for the strike price of $40, even though it is trading at or below $30.