FRM Part I · FRM Exam Part I · Exotic Options
A European up-and-out call has a strike of 50 and a barrier of 45, with the current stock price at 40. Which statement is correct?
The option is worthless from the start. To finish above the 50 strike the stock must first pass the 45 barrier, which extinguishes the option. Since barrier is below the strike, no scenario produces a payoff.
- AThe option is worth zero if the barrier is touched, and since any payoff requires a price above 50, which is above the barrier, it is worthless from inceptionCorrect
- BThe option is valuable because the barrier is above the current price
- CThe option has the same value as a vanilla call
- DThe option behaves like an up-and-in call
Explanation
For a payoff, the stock must finish above 50. To get there from 40 it must cross 45, which knocks the option out. So the option can never pay off and is worth zero. The up-and-out call with barrier at or below strike is worthless.
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