Skip to content

FRM Part I · FRM Exam Part I · Exotic Options

A trader holds a European down-and-out call on a stock with strike 50 and a barrier at 40. Compared with an otherwise identical standard European call, which statement is correct?

The down-and-out call is worth no more than the standard call. It pays the same as the vanilla call if the barrier is never touched, and nothing if the barrier is hit, so its payoff never exceeds the vanilla payoff.

  1. AThe down-and-out call is always worth at least as much as the standard call
  2. BThe down-and-out call is always worth no more than the standard callCorrect
  3. CThe down-and-out call is worth more than the standard call only when the barrier is above the strike
  4. DThe down-and-out call has the same value as the standard call because the barrier is below the strike

Explanation

A knock-out option has the same payoff as the standard option if the barrier is never hit, and zero if it is hit. Its payoff can therefore never exceed that of the standard option, so its value is less than or equal to it. The option to be extinguished only removes value.

Did you get it right without looking?

One question tells you little. A timed set on Exotic Options shows your real accuracy, how long you take and where you lose marks.

Practise Exotic OptionsFree diagnostic mock

More Exotic Options questions