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knock-out options

An FX Knock-out Option is a contract through which an issuer commits to sell a foreign currency on a future date at a more attractive pre-defined rate than the standard forward rate, on condition that the exchange rate does not hit the Knock-out Level at any time during the contract.

Due to their complex character, knock-out options are not the most suitable products for corporate treasurers wishing to protect their profits from FX risks. There are more efficient alternatives like Dynamic Hedging.

Knock-out options include the following elements:

 

Financial Asset:   EUR/USD
Position at Maturity:   EUR/USD short
Amount:   1,000,000
Spot Rate:   0.9350
Forward Rate:   0.9275
Knock-out Option Rate:   0.9150
Knock-out Level:   0.8800
Tenor:   6 months

 

Knock out options are speculative products that do not guarantee to hedge against FX risk. If the exchange rate hits the Knock-out level, the option will be cancelled and the buyer will remain exposed to currency volatility.