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.
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Finance: What are Interest Rate Options?3 Views
Finance Allah Shmoop What are interest rate options All right
people you may need a big loan in three years
It's all about the storms And the big sees you
know with the amount of destruction they'll do to the
oil rigs you manage out there right you big oil
company Global warming has in fact changed weather patterns So
you have no idea if you'll actually need five billion
dollars in debt to buy and or build a new
one But today you mister or missus or Miss CEO
today interest rates are cheap The Fed is almost giving
away money in two and a half percent interest which
means that you can get a loan at Summit for
ish percent interest rate since so much money is involved
here like five billion dollars Well the move of one
percent or one hundred basis points is big and times
were good now and well you really want certainty So
in order to reduce risk you buy an interest rate
option that is You pay one hundred million dollars for
the right three years from now too Then get alone
of call it three billion dollars and note that you
don't have to get the full five billion dollars if
rates go up in the last two billion is expensive
money while fen you figure inflation has hit big time
and you can just well raise prices on oil and
you know or your services to the big oil Cos
right because that's what you do for a living That
hundred million dollars is a call option on future interest
rates that well may or may not be there right
Like it might expire worthless Or it might be worth
a fortune if rates or seven eight nine percent So
what happens if the Fed doesn't budge and rates are
identical in three years Toe what they are today you
lose it All right You lose all hundred million dollars
for that call option You bought Goldman Sachs or Morgan
Stanley or whatever Big Bank took the risk on the
other end of that trade Just made one hundred very
large just for you know being there But you don't
feel bad about it Why Well because interest rates are
still then super cheap At four percent it's kind of
like term life insurance only for the finance world Piccoli
for big oil companies or big capital expense kind of
cos every month that goes by and you lose the
fifty eight bucks you spent on that million dollar policy
you personally bought for your wife and kids If you
get hit by a bus well you feel good to
have wasted that fifty eight dollars because well the alternative
is you know that you don't have a life You
know we don't just mean that Then your social calendar's
empty And your best friends are your Star Wars action 00:02:26.92 --> [endTime] figures no
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