Template:Eqderiv Knock-In and knockout summ

If you have forgotten what it is like to have a tension headache, and for some reason feel like being reminded, the sterling work of ISDA’s crack drafting squad™ on Sections 1.44, for Knock-in Events, and Section 1.45, for Knock-out Events, might just be the aneurysm you are looking for.

It is hard not to have some grudging admiration for the rock-jawed consistency of it: having strangled their way through the language once, the inverse is identical but for “-in” becoming “-out” and a single reference to the event having occurred, for a Knock-in Event, and having not occurred (for a Knock-out Event), as this comparison ably illustrates.

With a Knock-in Event, nothing happens until the event — the Transaction “knocks in” — and then you’re in business. With a Knock-out Event, everything happens until the event, and then pop, you’re out.

The concept of Knock-ins and Knock-outs is, thus, basically simple but good GOD ISDA’s crack drafting squad™ make a meal of it. If you stipulate a Knock-in Price below your strike price, if the Underlier falls far enough to hit that price, or go below it, you have a Knock-in Event. If your Knock-in Price is above your initial strike, then the Underlier has to go up to hit it. Whether you have hit it is measured at specified certain Knock-in Valuation Times on Knock-in Determination Days.

Exactly the same goes for Knock-outs, only in mirror image.

Can we envisage a circumstance in which the Knock-in Reference Security is not the Underlier? Well, I can’t but I am sure someone at Goldman could think of one.