What is a Double No-Touch Option
A double no-touch option is an exotic type of option which gives the holder a specified payout if the underlying asset price remains within a specified range until expiration. The buyer negotiates the price range, called the barrier levels, with the seller. The seller is often a brokerage firm.
The maximum possible loss is the cost of setting up the option. The maximum profit is the negotiated payout amount minus the cost of purchasing the option.
Double no-touch and the converse, double one-touch, options are both in the binary options category. Binary options have a "yes or no" logic basis. Either they pay the full amount, or they pay zero. The holder is obligated to exercise the option if held to expiration.
BREAKING DOWN Double No-Touch Option
Because they have a "yes or no," or binary payout, double no-touch options are in the binary options category. They are essentially bets that the underlying asset will not move 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."
While the landscape here is fraught with danger, the double no-touch option could be useful if an investor believes the price of an underlying asset will remain range-bound over a specified period. Double no-touch options are popular among traders in the forex (FX) markets.
Several factors will impact the cost of the option. Just as the shorter the time to expiration will increase the cost of the option, so will wider barrier levels. Both are due to the higher probability that the underlying price will not touch or exceed the barriers.
For example, if the current USD/EUR rate is 1.15, and the trader believes this rate will stay static over the next 15 days, the trader could use a double no-touch option with barriers at 1.10 and 1.20. The investor can profit if the rate does not move beyond either of the two barriers.
The trader could also accomplish the same goal with traditional options by using a short strangle strategy or a short straddle strategy. However, additional risk control would be necessary since there is no capping of potential losses as there are with the double no-touch. The advantages of regular options include liquidity, transparency, and minimal counterparty risk.
A double no-touch option is also the converse of a double one-touch option. The holder of this option receives the payout if the price of the underlying asset touches or moves through either of the barrier levels. Again, the same result is possible with a long strangle or long straddle, and the profit potential is theoretically unlimited.
Double No-Touch Options vs. Regular Options
As previously mentioned, double no-touch options are not the same as regular or vanilla options. No-touch and all other binary options are primarily over-the-counter instruments. The buyer and seller negotiate the terms, which includes 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.