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.
Glossar
Payoff
Mechanism ⎊ Payoff, within cryptocurrency derivatives, represents the calculated financial outcome of a contract at expiration or a specified trigger event, determined by the underlying asset’s price relative to the contract’s strike price and other parameters.
Barrier Option
Trigger ⎊ These derivative instruments activate or expire based on the underlying asset reaching a specific price threshold.
Predetermined Barrier
Trigger ⎊ A predetermined barrier, within cryptocurrency derivatives, functions as a specific price level that, when breached, initiates a pre-defined action, often the activation or deactivation of a contract or a change in its parameters.
Payoff Structure
Structure ⎊ The payoff structure defines the potential profit or loss profile of a financial instrument at expiration, based on the price of the underlying asset.