What is Barrier Option?

Legal Definition
In investment, a barrier option is an exotic option on an underlying asset whose existence depends upon the underlying asset's price reaching pre-set barrier level: the derivative either springs into existence or, if the option already exists, it is extinguished.

  • Where the option springs into existence upon the underlying asset's price reaching the barrier level, it may be called an up and in, knock-in, or down and in option.
  • Where the option is extinguished upon the underlying asset's price reaching the barrier level, it may be called an up and out, knock-out, or down and out option.

A barrier option has a lower premium than a similar option without a barrier. Barrier options were created to provide the hedge of an option at a lower premium than a conventional option. For example, if an investor believes that the price of a particular common stock, now trading at $100 per share, will increase within the next 6 months, but will not reach $150 per share, you could buy the option with a barrier level of $150 at a lower premium than a conventional option on the same common stock.

There are disputes over the tax treatment of these options in the United States.
-- Wikipedia
Legal Definition
A COMPLEX DERIVATIVE contract that creates or extinguishes an underlying EUROPEAN OPTION as the price of the market reference moves through a specified BARRIER. Four versions of the barrier option are commonly used, including the DOWN AND IN OPTION, DOWN AND OUT OPTION, UP AND IN OPTION, and UP AND OUT OPTION. The fact that the underlying option may be extinguished, or may never be created, means that a barrier option is typically less expensive than an otherwise equivalent European option. Also known as KNOCKIN OPTION, KNOCKOUT OPTION. See also REVERSE BARRIER OPTION.