What Is a Double One-Touch Option?
A double one-touch is a type of digital (binary) option that gives the holder a specified payout if the underlying asset price moves outside of a specified range at any point before its expiration. The buyer negotiates the price range with an upper and lower level, called the barrier levels, with the seller. The seller is often a brokerage firm. It is also known as a double barrier option.
Either one of the barrier levels must be breached prior to expiration for the option to become profitable and for the buyer to receive the payout. If neither barrier level is breached prior to expiration, the option expires worthless and the trader loses all the premium paid to the broker for setting up the trade.
A one-touch option (without the double) will only have a single barrier level.
- A double one-touch option is a type of barrier and binary option that pays out if the underlying price exceeds either an upper or lower price level before expiration.
- This type of exotic option is most often used in forex markets to profit off of volatility in a currency pair.
- If neither barrier is touched before expiration, the option expires worthless and the seller collects the full premium.
How Double One-Touch Options Work
Double one-touch and the converse, double no-touch, options are both barrier options. Because they have a “yes or no,” or binary payout, they are in the binary options category. As such, they are essentially bets that the underlying asset will move by a specified amount by a certain date.
Because of this structure, they bring an element of gambling into the equation. Indeed, they and their sellers are prone to fraud, which is perhaps why many jurisdictions ban these products. The payouts tend to favor the sellers, not unlike the way gambling games in casinos favor the “house.” In many ways, the double one-touch option is similar to being long an options straddle, in that it pays out if the price moves either up or down beyond certain points. The difference is that the barrier option nature requires just one ‘touch’ to trigger a payout.
While the landscape here is fraught with danger, the double one-touch option could be useful if an investor believes the price of an underlying asset will move significantly over a specified period. Double one-touch options are popular among traders in the forex (FX) markets.
Several factors will impact the cost of the option. Just as the longer the time to expiration will increase the cost of the option, so will tighter barrier levels. Both are due to the higher probability that the underlying price will touch or exceed the barriers.
Knock-In & Knock-Out
A knock-in barrier option becomes valid when the underlying exceeds either barrier. It then acts as any other options contract, giving the holder the right but not the obligation to buy the underlying asset at a specific price at or by a specific date. A knock-in option has no value until the underlying reaches a certain price. The critical concept is if the underlying asset reaches either barrier at any time during the option’s life, the knock-in option is brought into active existence and will remain that way until expiration. It does not matter if the underlying moves back to pre-knock-in levels.
A knock-out barrier option becomes invalid, or ceases to exist, when the underlying touches either barrier. Thus, it becomes worthless at that point.
Other Types of Barrier Options
Barrier options come in single and double barrier varieties, as covered above. Single barrier options come in four varieties: down-and-in, down-and-out, up-and-in, and up-and-out, covering all possibilities of single barrier and the knocking feature.
However, there are several others, including binary options, which pay a set amount if a barrier is reached or zero if it is not reached.
Example of a Double One-Touch Option
For example, if the current USD/EUR rate is 1.15, and the trader believes this rate will change significantly over the next 15 days, the trader could use a double one-touch option with barriers at 1.10 and 1.20. The investor can profit if the rate moves beyond either of the two barriers
Double One-Touch Options vs. Regular Options
As previously mentioned, double one-touch options are not the same as regular or vanilla options. One-touch and all other binary options are primarily over-the-counter instruments. The buyer and seller negotiate the terms, which include the payoff amount, barrier levels, and expiration date. Note that there are no strike prices. Also, the seller is obligated to exercise the options, either at the agreed payout, at zero, or at expiration.
Regular options trade on formal exchanges and give the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price by or on a particular date. They also have standardized strike prices, expirations, and contract sizes. This standardization gives them the advantage of liquidity in a secondary market, and more assurances for both the buyer and seller that the trade and exercise, if it occurs, will take place promptly.
The trader in the example above could accomplish the same goal with traditional options by using a long strangle strategy or a long straddle strategy. The advantages of regular options include liquidity, transparency, and minimal counterparty risk.
A double one-touch option is also the converse of a double no-touch option. The holder of this option receives the payout if the price of the underlying asset remains within the two barrier levels. Again, the same result is possible with a short strangle or short straddle, although the loss potential is theoretically unlimited.