Asset-at-Expiry Binary Barrier Option

Okay, let’s break it down simply. An asset-at-expiry binary barrier option is a special kind of deal. It’s not like your everyday option, though. It’s got a twist.

When you buy one of these puppies, you’re betting on whether something called the “underlying market reference” will hit a specific price. That price is the “barrier”. And if it does hit the barrier, even just for a quick second, during the time you have the option – bam! You get paid a fixed amount of an asset. Cool, right?

The Underlying Market Reference

This “underlying market reference” thing sounds fancy, but it’s just a way of saying what you’re betting on. It could be a stock, a commodity like gold or oil, or even a currency. The point is, it’s got a price that goes up and down. And that’s what matters for your option.

The Barrier Price

Next, we’ve got the “barrier.” This is the magic number. It’s the price level that the underlying market reference has to hit for you to get paid. Depending on the option, the barrier might be higher than the current price or lower.

How Does It Work in Real Life?

Picture this: you think gold prices will go wild and hit $2000 an ounce. So you buy an asset-at-expiry binary barrier option with gold as the underlying market reference, $2000 as the barrier, and, let’s say, a one-month expiry.

Scenario 1: Gold Hits the Barrier

Some big news hits two weeks later, and gold spikes to $2050. Boom! The price smashed through your $2000 barrier. Even if it drops back down right after, it doesn’t matter. As long as it touched or went over $2000, even for a microsecond, you’re golden (pun intended).

You get paid the fixed asset amount specified when your one-month option expires. Depending on the choice, it could be a set amount of gold or cash. But the point is, you win.

Scenario 2: Gold Doesn’t Hit the Barrier

Now, let’s say there’s no big news. Gold chugs along, and it’s sitting at $1950 after a month. It never got to your $2000 barrier.

In this case, when your option expires, you get diddly-squat. The underlying market reference never hit the barrier during the option’s life, so the option expires worthless. They’re the breaks.

Why Would You Use These Options?

Alright, so why bother with these barrier options anyway? Couple reasons:

1. They’re Cheaper

Usually, asset-at-expiry binary barrier options are cheaper than vanilla options. That’s because there’s an extra condition – hitting the barrier. With a regular option, you just need the price to be above (for a call) or below (for a put) the strike price at expiry. But with the barrier option, it has to hit that barrier at some point.

This extra condition makes it harder to get paid, so the options are cheaper. This is good if you’re on a budget but still want to play the market.

2. You Can Bet on Volatility

These options are a way to bet on market volatility without actually caring about the direction. Huh? Here’s the thing – with a barrier option, you don’t necessarily need the price to finish above or below a certain level. You just need it to hit the barrier at some point.

So even if gold bounces around like crazy, as long as it hits your $2000 barrier at some point, you win. The final price could be $1800 or $2200, doesn’t matter. You’re betting on the journey, not the destination.

The Nitty Gritty Details

Okay, it’s time to get into the weeds a bit.

Types of Barriers

There are two main types of barriers: knock-in and knock-out.

• Knock-in means the option only activates if the underlying hits the barrier. If it never hits, the option never even comes to life.
• Knock-out: This is the opposite. The option starts active, but if the underlying hits the barrier, the option immediately dies. Kaput.

Asset-at-expiry binary barrier options are typically knock-in. The barrier activates the option, and then you wait to see if you get paid at expiry.

Continuous vs. American Barriers

Another detail is whether the barrier is “continuous” or “American.”

• Continuous barrier: The underlying market reference must touch the barrier instantly for it to count.
• American barrier: The underlying market reference has to touch the barrier at a specific, pre-determined time, like the end of each trading day.

Continuous barriers are more common. They give you more chances to win.