Knock-In Option

Riddle time: what is an option that was never really an option?

Sounds like a meditation on the perception of free will in a universe that might be deterministic on a subatomic level. But...no. We're talking about financial markets.

In financial terms, options give investors the right, but not the obligation, to buy or sell an underlying asset (a stock or commodity or whatever) at a set price within a set period of time. So...you might purchase an option to buy 100 shares of XOM stock at $80 a share, with the contract expiring in June.

A knock-in option generally works like a normal option, except it has a barrier price built in. If the underlying asset never reaches a certain price threshold, then the knock-in option never becomes a true option. When it expires, it's like it never existed. However, if the minimum price threshold is met, the contract becomes a regular option.

You buy a knock-in option for XOM at $80 a share, with the contract expiring in June. It has a barrier price of $75 a share. The stock is currently trading at $70. If June comes around and the stock is trading at $73, the option doesn't exist. The contract just disappears into the gloaming, like a gauntleted Thanos just snapped his fingers.

However, if the stock gets to $76 in late May, then the contract becomes a live option. Now you just need it to rise above $80, so you can exercise the option and book a profit.