Barrier Options: Basics

The payoff of a barrier option is determined by whether or not the underlying asset reaches a certain predetermined level. We explain knock-in and knock-out calls and puts, and differentiate between regular and reverse barrier options. We use an example to illustrate the payouts for two sample barrier options, investigate the definition of a breached barrier, and briefly outline some variations of barrier options, including double barriers, rainbow barriers, faders, and rebates.