Dual Barrier Option

A Dual Barrier Option is an agreement to give the purchaser of the option the right to exchange a known quantity of one security for a known quantity of a specified currency - subject to the behavior of the price of the underlying security with respect to two price barriers. Such a security is usually used to lower the cost of acquiring a similar option without such barriers.

The following is the screen display for a Dual Barrier Option that if exercised will deliver CAD 10,000 in exchange for DEM 12,000 on June 30, 2001 (provided that before this date the DEM price of one CAD stays between DEM 1.0 and DEM 1.4 per CAD):

DuBarOpt.gif

The following describes some attributes of Dual Barrier Options:

Strike Price and Currency:

The Strike Price and Strike Currency specify the amount that must be exchanged per unit of the underlying security, if and when the option is exercised.

For Dual Barrier Options the Strike Price Currency must be the same as the Exchange Currency. [See also Barrier Prices and Currency below.]

Transaction Currency:

For most Dual Barrier Option transactions, the exchange currency is the same as the transaction currency. However, sometimes it is necessary to pay for a Dual Barrier Option in a different currency from the exchange currency. This is facilitated by specifying the required payment currency as the transaction currency

Option Expiry Date:

This is the date by which the option must be exercised if the holder of the option wishes to exchange the specified strike price for the underlying security, as per the terms of the option contract - provided that the option satisfies the barrier requirements.

Delivery Date:

This is the date on which the exchange, as specified by the contract, must occur - if the option can be exercised.

Option Type:

The following two types of options can be specified:

Exercise Style:

The following two types of exercise styles can be specified:

Pricing Model:

The pricing model to be used during valuation can be chosen from the following models:

Barrier Prices and Currency:

The Barrier Prices and Barrier Currency specify the barrier levels that must either be avoided or crossed by the price of the underlying security - depending on the type of barrier specified.

The Barrier Price Currency must be the same as the Exchange Currency.

Barrier Growth Rates and Start Date:

The Barrier Price levels can be specified along with growth rates. Most often the barrier growth rate is set to zero which corresponds to a constant barrier level. However, if a non-zero growth rate is specified this results in a curved barrier.

The Barrier Value at some time T in years after the Start Date is calculated as follows:

BarrierValue(T) = InitialBarrierValue * exp ( BarrierGrowthRate * T )

Barrier Monitoring Frequency:

The Barrier Monitoring Frequency specifies how often the price of the underlying security will be checked against the specified barrier levels in order to determine whether or not the barrier levels have been reached.

Rebate Amount:

The Rebate Amount specifies the exchange currency amount per unit of the underlying security that will be rebated to the holder of the option, provided that the desired barrier result does not occur.

Initial Reference:

The Initial Reference is used to capture the starting level of the underlying security level as measured in the exchange currency.

Current Reference:

The Current Reference is used to identify the most recent record of the underlying security level as measured in the exchange currency.

The current reference value is updated by the Reset All Securities command. The current reference values for Dual Barrier Options must be reset at the same frequency as the Barrier Monitoring Frequency. [Note: Dual Barrier Options with CONTINUOUS or HOURLY Barrier Monitoring Frequencies are only scheduled to be reset on a daily basis.]

Barrier Status:

The Barrier Status monitors if either barrier has been touched since the barrier option was created. The Reset All Securities command also updates the barrier status if either barrier has been reached during the last update.

The barrier status can also be directly set or reset by the user.

Intrinsic Multiplier:

The options underlying most Dual Barrier Options have an intrinsic multiplier of 1.0 which means the option holder has a right to 100% of the intrinsic value. However, in some cases the holder of the option has a right to some fraction or multiple of the intrinsic value. The intrinsic multiplier attribute allows such a feature to be captured when specifying the underlying option.

Option Value Cap:

The options underlying most Dual Barrier Options do not have a cap on the total payout of the option. However, in some cases the issuer of the option limits the payout to a specified amount. The Option Value Cap attribute allows such a feature to be captured when specifying the underlying option.

The Cap Limit Currency must be the same as the Exchange Currency and this amount is deemed payed as soon as the Cap Limit is reached.

Earnings:

There are no earnings associated with positions in Dual Barrier Options.

Valuation:

The value of a Dual Barrier Option is obtained by using published finance formulas. [See Kunitomo-Ikeda, Hull, Strickland and Clewlow.]

To value a Dual Barrier Option at a particular World State, it is necessary for that World State to contain:

In addition to the above World Variables, it may also be necessary for that World State to contain:

Pricing:

The price of a specified Dual Barrier Option can also be obtained by using the Valuation window and directly specifying the variables required by the pricing formula:

DuBaOpPw.gif