What Is a “Barrier Option” and How Does Its Payoff Structure Affect Its Liquidity?

A Barrier Option is an exotic option whose payoff depends on whether the underlying asset's price reaches or "hits" a predetermined barrier level during the option's life. The path-dependent nature of its payoff makes it significantly more complex to price and hedge than a vanilla option.

This complexity limits the number of market makers willing to quote it, resulting in very low liquidity and extremely wide bid-ask spreads, leading to high potential slippage.