Summary:
A double no-touch option is a kind of exotic option contract or financial derivative that hands the holder a payout if the price of the underlying asset continues to be within a specific range throughout the lifetime of the option. This blog gets into the details of how investors may start using them.
Introduction to double no-touch option
A double no-touch option is a kind of exotic option contract or financial derivative that hands the holder a payout if the price of the underlying asset continues to be within a specific range throughout the lifetime of the option. This is a variant of the more common single no-touch option.
The highest possible loss that the holder can incur is the cost of setting the option up. The most that an investor can earn is the payout that had been agreed upon, minus the cost of setting up the option. In most cases, the buyer conveys the extent of risk that they are willing to take. Depending on this amount, the broker agrees to provide a percentage in terms of payout. Because of this, the structure of the double no-touch option remains simple.
Double one-touch and double no-touch both fall in the binary category, implying they have either of two outcomes – yes or no. Either the payout is in full, or zero.
How double no-touch options work:
The following is a simplified explanation of how double no-touch options work:
- Range: There are two barrier levels in the option. One is below the existing market price (known as the lower barrier) and the other one is above the existing market price (known as the upper barrier). These barrier levels are used to define the range within which the price of the underlying asset must stay during the lifetime of the option for it to have a payout. Failing this, the payout is nil.
- Payout: If the price of the underlying asset continues to be within the specified range (between the lower and upper barriers) throughout the lifetime of the option, the holder is given a fixed payout at the option's expiration. This amount is agreed upon initially. These options are said to be in the binary category because the outcomes will be either a yes (payout) or no (no payout).
- No-touch characteristic: If the price of the underlying asset reaches or crosses any of the barrier levels during any point of the option's lifecycle, the option is deemed to be worthless, and the holder does not receive any payout. It is because of this that option is called a 'no-touch' option. The price cannot touch or breach either of the barrier levels.
Advantages of double no-touch options:
Double no-touch options have many advantages, making an attractive choice for specific traders and investors in certain market conditions:
- Potentially high returns: Typically, these options provide relatively high payouts in comparison to standard options, especially when the lower and upper barriers are spread out wide.
- Defined risk: The risk for these options is limited to the amount that is paid as a premium for purchasing the option. Investors are aware from the beginning exactly how much they stand to lose if the price barriers are breached. This can be very handy for managing risk.
- Range-bound market strategy: These options are suited well for markets that have limited volatility and traders anticipate the price of an asset to remain within a specified range. This enables traders to tailor their strategies to their interests and market conditions.
- Speculative opportunities: Investors who have strong convictions that an asset will be within a particular price range use these options to convey this view and subsequently profit from it.
Use cases of double no-touch options:
The main appeal of double no-touch options is the ability to offer significantly higher payouts in comparison to traditional options. However, they do come with elevated degrees of complexity in predicting movements in prices. Investors use these options when they are thoroughly convinced that the price of the underlying asset will continue to be within the specified range. They invest in this hoping to capitalize on this expectation and certainty.
Most of the time, these options find applications in forex markets, commodities and other financial markets where investors are keen on hedging against specific shifts in prices or anticipate range-bound price movements. However, in comparison to standard options, they are slightly more complex and have higher degrees of risk. This is why these options are suitable for investors and traders who have experience and significantly large volumes of capital to mitigate losses.
Summing up
Double no-touch options are popular among new and old investors alike, though the significant drawback is that if the price of the underlying asset touches or crosses either of the barrier levels during the lifetime of the option, the payout is nil, and the option is worthless. The premium paid by the investor is lost. These options are more complex to trade and need a good comprehension of pricing dynamics, market conditions and strategies for risk management. With a little effort for research and the help provided in this blog, you should be able to touch these options in no time at all.