Barrier options are classified as exotic derivatives and are attractive due to their low cost premiums when compared to standard options. The main defining element of a barrier option is that its payout depends on whether the option has reached or exceeded a predetermined price ‘barrier’.

Knock-out and knock-in barrier options are the two most common types of barrier options. A knock-out barrier option requires the option to exceed a designated price before the option becomes active and can generate a payout. This payout accelerates as the underlying asset rises above the barrier price. A knock-in barrier option, on the other hand, gets activated only when the option rises and exceeds the barrier price and pays out when the asset price rises above the exercise price.

Barrier options can be used to hedge a portfolio of investments, limiting an investors downside and protecting against the volatility associated with the markets. They offer investors the flexibility to shape the risk, reward of their trades. Additionally, barrier options can be tailored as per a specific investment objective.

Barrier options are traded over-the-counter (OTC), and occur when two parties agree to trade a specific quantity of a security at a specified price. However, these agreements are subject to the possibility that the option may or may not be triggered.

Barrier options are suited for hedging strategies and offer low cost premiums, relative to other forms of derivatives such as standard options. The use of barrier options to hedge positions can provide investors with a way to protect their downside, while still offering the potential for return.