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Barrier option

Barrier option Definition

A barrier option is a type of financial option where the option to exercise depends on the underlying crossing or reaching a given barrier level.

Barrier options were created as a way to provide the insurance value of an option without charging as much premium. If you believe that IBM will go up this year, but you're willing to bet that it won't go above $100, then you can buy the barrier and pay less premium than the vanilla option.

The valuation of barrier options can be tricky, and an effort to emply Black-Scholes methods of valuation can be misleading. Monte Carlo option models often prove more useful here.

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