DEFINITION of Knock-In Option
Knock-In Option is an option contract that becomes active only when a certain price is reached. For example, one may purchase a knock-in option with a “knock-in price” of $35 and a strike price of $45. If the price of the underlying asset never reaches $35 at any point over the course of the option’s life, the option is treated as if it never existed in the first place. If it does, however, it becomes a plain vanilla option (that is, a regular option) with a strike price of $45.
WHAT IT IS IN ESSENCE
A knock-in option is an option contract that only comes to life when it reaches a certain price level. It must reach that level before expiration. In other words, it is an option that activates, i.e., knocks in, only when it hits a certain price.
In investing, an option is a contract that gives the purchaser the right, but not the obligation, to buy or sell a stock’s index or future. With an option, buyers can buy or sell at a specific price before a certain future date.
InvestmentandFinance.net has the following definition of the term:
“An option that automatically activates or comes into life only when a certain price of its underlying is hit.”
Knock-out and knock-in option
Some options, such as knock-in options, spring into existence when the asset reaches a pre-set barrier level. Others, however, such as knock-out options, die when the underlying asset’s price reaches the barrier level.
In this context, the ‘barrier level‘ means a specific price.
Therefore, the opposite of knock-in options is knock-out options.
Barrier options have lower premiums than similar options with no barrier.
HOW TO USE
Knock-in option is usually straightforward European options until, or from, the time the underlying reaches the trigger level. With a knock-out option, the option exists in the usual way, and either it is exercised at expiry or it expires worthless, depending on the underlying asset.