DEFINITION of 'Up-And-Out Option'

A type of barrier option that becomes worthless if the price of the underlying asset increases beyond a specified price level (the "knock out" price). If the up-and-out option stays below the knock out price, then the holder may be entitled to a payout. Up-and-out options are considered to be exotic options and are not widely traded.

BREAKING DOWN 'Up-And-Out Option'

An up-and-out option would likely only be created through a direct agreement between large institutions or market markers better able to analyze and understand the risks involved. For example, it can be used by a portfolio manager as a less expensive method to hedge against losses on a short position. The hedge would be less expensive than buying a vanilla call option, but the hedge would be imperfect, since the buyer would be unprotected if the security price increased beyond the barrier price.

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