Template:Eqd Knock summ

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The Knock-in and Knock-out provisions define the mechanics of barrier options commonly used in structured equity derivatives. The customer’s option rights depend on the Underlier reaching (it it gets there, the trade “knocks-in”) or not reaching (if it reaches it, it’s a knock-out) certain price levels during specified observation periods.

The knock-in or knock-out level is a barrier. The definitions carefully specify how these events are determined, including the observation times, handling of market disruptions, and what happens if the parties disagree (the Calculation Agent — AKA dealer — decides).

You tend not to see these products being used in synthetic prime brokerage. These are typically more complex and customized products, often used in structured products sold to retail investors via structured notes (for reasons unknown, structured notes remain popular investments in Asia despite having been wildly out of fashion in Europe and the US since 2008). You may also see sophisticated institutional investors looking for specific payoff profiles and corporates seeking specific hedging strategies

The barrier features can make the option cheaper than it would be if a straight-out put or call since there are more ways for them to, er, end up worthless. Buyers get exposure to more exotic payoffs, at a lower premium, buuuut by taking more complex (and, quand l’ordure se frappe le ventilateur bigger) risks.

Be careful to monitor valuation times, disruption events, and determination periods closely, since significant value can appear or disappear based on exactly when or whether a barrier is deemed to have been hit.