19 August, 2022

I build businesses, both as independent startups and as new initiatives within large global companies. This series of posts is based on an FX Options training course that I delivered whilst contributing to building FX businesses at a number of investment banks. If you are looking to build a business and require leadership then please contact me via the About section of this website.

FX Options Guide - Section 17 - Binary Options And Double Knockout Option

Binary Options And Double Knockout Option Introduction

In this section we deepen our look at barrier options by looking at binary options and double knockout options. To get the most from this section you should first have covered the sections on reverse knockout options, reverse knockin options, knockout options and knockout option risk management considerations.

Binary Options

Binary options differ from other options in that they have a fixed payout depending on whether one or more barriers are either triggerd or not triggered. In this guide we will look very briefly at the two most common forms of binary option, the single barrier one touch and the double barrier double no touch.

One Touch

The one touch comes from the family of barrier products known as digitals. One touches are usually incorporated into structures, and rarely trade in their own right. The exception to this is when exotic option market makers trade one touches in the interbank market to adjust the risk profile of barrier option portfolios.

Features

A one touch differs from other barrier options in that it does not give the buyer the right to buy or sell a currency at a particular rate. A one touch has a fixed payout amount in a pre-specified currency if a pre-specified rate is traded in the market during global trading hours from the time at which a trade is executed, until the expiration time on the expiration date of the one touch. The buyer of a one touch receives the payout amount at expiration if the barrier is triggered.

Double No Touch

The double no touch, also known as a range binary, first came to prominence in 1994, after a previously volatile USD vs Europe market started to range trade for a few months. For the first time it became possible to take a short volatility position with a well-defined worst case downside.

Features

The buyer of a Double No Touch pays an initial premium for the right to receive a fixed payout amount at expiration if neither of two levels are touched prior to expiration. The barriers are set such that spot is between the two barriers. If spot trades at or beyond either of the barriers the option terminates. The price of a double no touch is quoted as a percentage of the final payout amount.

Double Knockout Option

Double knockouts were first used in 1994, and were a natural extension of the growth in the use of reverse knockouts.

The double knockout option differs from a standard option by the additional feature of two outstrike prices. If spot trades at or beyond either outstrike price during global trading hours from the time at which a trade is executed, until the expiration time on the expiration date of the option, then the option terminates. If the outstrikes are never triggered then the pay-off from the double knockout option at expiration is identical to that of the equivalent standard European option.

The cost of a double knockout option is less than the cost of the equivalent standard option, and less, the equivalent knockout and reverse knockout options.

The outstrikes of a double knockout option are set such that one is above spot and the other is below the initial spot price.

Next Section - Barrier Option Variations

In the next section we continue our introduction to barrier options by looking at barrier option variations.

About The Author

I build businesses, both as independent startups and as new initiatives within large global companies. If you want to know more then visit the About section of this website.