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Down-and-out option

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Definition of Down-and-out option

Down-and-out Option Image 1

Down-and-out option

Barrier option that expires if asset price hits a barrier.



Related Terms:

Abandonment option

The option of terminating an investment earlier than originally planned.


American option

An option that may be exercised at any time up to and including the expiration date.
Related: European option


American-style option

An option contract that can be exercised at any time between the date of purchase and
the expiration date. Most exchange-traded options are American style.


Arbitrage-free option-pricing models

Yield curve option-pricing models.


Asian option

option based on the average price of the asset during the life of the option.


Bargain-purchase-price option

Gives the lessee the option to purchase the asset at a price below fair market
value when the lease expires.


Barrier options

Contracts with trigger points that, when crossed, automatically generate buying or selling of
other options. These are very exotic options.


Down-and-out Option Image 2

Basket options

Packages that involve the exchange of more than two currencies against a base currency at
expiration. The basket option buyer purchases the right, but not the obligation, to receive designated
currencies in exchange for a base currency, either at the prevailing spot market rate or at a prearranged rate of
exchange. A basket option is generally used by multinational corporations with multicurrency cash flows
since it is generally cheaper to buy an option on a basket of currencies than to buy individual options on each
of the currencies that make up the basket.


Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.


Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.


Borrower fallout

In the mortgage pipeline, the risk that prospective borrowers of loans committed to be
closed will elect to withdraw from the contract.


Breakout

A rise in a security's price above a resistance level (commonly its previous high price) or drop
below a level of support (commonly the former lowest price.) A breakout is taken to signify a continuing
move in the same direction. Can be used by technical analysts as a buy or sell indicator.


Builder buydown loan

A mortgage loan on newly developed property that the builder subsidizes during the
early years of the development. The builder uses cash to buy down the mortgage rate to a lower level than the
prevailing market loan rate for some period of time. The typical buydown is 3% of the interest-rate amount
for the first year, 2% for the second year, and 1% for the third year (also referred to as a 3-2-1 buydown).


Buydowns

Mortgages in which monthly payments consist of principal and interest, with portions of these
payments during the early period of the loan being provided by a third party to reduce the borrower's monthly
payments.


Buyout

Purchase of a controlling interest (or percent of shares) of a company's stock. A leveraged buy-out is
done with borrowed money.


Call an option

To exercise a call option.


Call option

An option contract that gives its holder the right (but not the obligation) to purchase a specified
number of shares of the underlying stock at the given strike price, on or before the expiration date of the
contract.
Call premium
Premium in price above the par value of a bond or share of preferred stock that must be paid to
holders to redeem the bond or share of preferred stock before its scheduled maturity date.


Cashout

Refers to a situation where a firm runs out of cash and cannot readily sell marketable securities.


Compound option

option on an option.


Covered or hedge option strategies

Strategies that involve a position in an option as well as a position in the
underlying stock, designed so that one position will help offset any unfavorable price movement in the other,
including covered call writing and protective put buying. Related: naked strategies


Cramdown

The ability of the bankruptcy court to confirm a plan of reorganization over the objections of
some classes of creditors.


Currency option

An option to buy or sell a foreign currency.


Customary payout ratios

A range of payout ratios that is typical based on an analysis of comparable firms.


Days' sales outstanding

Average collection period.


Dealer options

Over-the-counter options, such as those offered by government and mortgage-backed
securities dealers.


Delivery options

The options available to the seller of an interest rate futures contract, including the quality
option, the timing option, and the wild card option. Delivery options make the buyer uncertain of which
Treasury Bond will be delivered or when it will be delivered.


Dividend payout ratio

Percentage of earnings paid out as dividends.


Doubling option

A sinking fund provision that may allow repurchase of twice the required number of bonds
at the sinking fund call price.


Down-and-in option

Barrier option that comes into existence if asset price hits a barrier.


Downgrade

A classic negative change in ratings for a stock, and or other rated security.


Elasticity of an option

Percentage change in the value of an option given a 1% change in the value of the
option's underlying stock.


Embedded option

An option that is part of the structure of a bond that provides either the bondholder or
issuer the right to take some action against the other party, as opposed to a bare option, which trades
separately from any underlying security.


Equity options

Securities that give the holder the right to buy or sell a specified number of shares of stock, at
a specified price for a certain (limited) time period. Typically one option equals 100 shares of stock.


European option

option that may be exercised only at the expiration date. Related: american option.


European-style option

An option contract that can only be exercised on the expiration date.


Exercising the option

The act buying or selling the underlying asset via the option contract.


Fallout risk

A type of mortgage pipeline risk that is generally created when the terms of the loan to be
originated are set at the same time as the sale terms are set. The risk is that either of the two parties, borrower
or investor, fails to close and the loan "falls out" of the pipeline.


Feasible target payout ratios

Payout ratios that are consistent with the availability of excess funds to make
cash dividend payments.


First-In-First-Out (FIFO)

A method of valuing the cost of goods sold that uses the cost of the oldest item in
inventory first.


Foreign currency option

An option that conveys the right to buy or sell a specified amount of foreign
currency at a specified price within a specified time period.


Full-payout lease

See: financial lease.


Futures option

An option on a futures contract. Related: options on physicals.


Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.


Greenshoe option

option that allows the underwriter for a new issue to buy and resell additional shares.


Index and Option Market (IOM)

A division of the CME established in 1982 for trading stock index
products and options. Related: Chicago Mercantile Exchange (CME).


Index option

A call or put option based on a stock market index.


Input-output tables

Tables that indicate how much each industry requires of the production of each other
industry in order to produce each dollar of its own output.


Intrinsic value of an option

The amount by which an option is in-the-money. An option which is not in-themoney
has no intrinsic value. Related: in-the-money.


Investor fallout

In the mortgage pipeline, risk that occurs when the originator commits loan terms to the
borrowers and gets commitments from investors at the time of application, or if both sets of terms are made at closing.


Irrational call option

The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the threshold to refinance).
Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).


Last-In-First-Out (LIFO)

A method of valuing inventory that uses the cost of the most recent item in
inventory first.


Leveraged buyout (LBO)

A transaction used for taking a public corporation private financed through the use
of debt funds: bank loans and bonds. Because of the large amount of debt relative to equity in the new
corporation, the bonds are typically rated below investment grade, properly referred to as high-yield bonds or
junk bonds. Investors can participate in an LBO through either the purchase of the debt (i.e., purchase of the
bonds or participation in the bank loan) or the purchase of equity through an LBO fund that specializes in
such investments.


LIFO (Last-in-first-out)

The last-in-first-out inventory valuation methodology. A method of valuing
inventory that uses the cost of the most recent item in inventory first.


Liquid yield option note (LYON)

Zero-coupon, callable, putable, convertible bond invented by Merrill


Lock-out

With PAC bond CMO classes, the period before the PAC sinking fund becomes effective. With
multifamily loans, the period of time during which prepayment is prohibited.


Lookback option

An option that allows the buyer to choose as the option strike price any price of the
underlying asset that has occurred during the life of the option. If a call, the buyer will choose the minimal
price, whereas if a put, the buyer will choose the maximum price. This option will always be in the money.


Liquid yield option note (LYON)

Zero-coupon, callable, putable, convertible bond invented by Merrill Lynch & Co.


Management buyout (MBO)

Leveraged buyout whereby the acquiring group is led by the firm's management.


Margin requirement (Options)

The amount of cash an uncovered (naked) option writer is required to
deposit and maintain to cover his daily position valuation and reasonably foreseeable intra-day price changes.


Multi-option financing facility

A syndicated confirmed credit line with attached options.


Naked option strategies

An unhedged strategy making exclusive use of one of the following: Long call
strategy (buying call options ), short call strategy (selling or writing call options), Long put strategy (buying
put options ), and short put strategy (selling or writing put options). By themselves, these positions are called
naked strategies because they do not involve an offsetting or risk-reducing position in another option or the
underlying security.
Related: covered option strategies.


Netting out

To get or bring in as a net; to clear as profit.


Open-outcry

The method of trading used at futures exchanges, typically involving calling out the specific
details of a buy or sell order, so that the information is available to all traders.


Option

Gives the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a
given date. Investors, not companies, issue options. Investors who purchase call options bet the stock will be
worth more than the price set by the option (the strike price), plus the price they paid for the option itself.
Buyers of put options bet the stock's price will go down below the price set by the option. An option is part of
a class of securities called derivatives, so named because these securities derive their value from the worth of
an underlying investment.


Option elasticity

The percentage increase in an option's value given a 1% change in the value of the
underlying security.


Option not to deliver

In the mortgage pipeline, an additional hedge placed in tandem with the forward or
substitute sale.


Option premium

The option price.


Option price

Also called the option premium, the price paid by the buyer of the options contract for the right
to buy or sell a security at a specified price in the future.


Option seller

Also called the option writer , the party who grants a right to trade a security at a given price in
the future.


Option writer

option seller.


Option-adjusted spread (OAS)

1) The spread over an issuer's spot rate curve, developed as a measure of
the yield spread that can be used to convert dollar differences between theoretical value and market price.
2) The cost of the implied call embedded in a MBS, defined as additional basis-yield spread. When added to the
base yield spread of an MBS without an operative call produces the option-adjusted spread.


Options contract

A contract that, in exchange for the option price, gives the option buyer the right, but not
the obligation, to buy (or sell) a financial asset at the exercise price from (or to) the option seller within a
specified time period, or on a specified date (expiration date).


Options contract multiple

A constant, set at $100, which when multiplied by the cash index value gives the
dollar value of the stock index underlying an option. That is, dollar value of the underlying stock index = cash
index value x $100 (the options contract multiple).


Options on physicals

Interest rate options written on fixed-income securities, as opposed to those written on
interest rate futures contracts.


Out-of-the-money option

A call option is out-of-the-money if the strike price is greater than the market price
of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of
the underlying security.


Outright rate

Actual forward rate expressed in dollars per currency unit, or vice versa.
outsourcing
he practice of purchasing a significant percentage of intermediate components from outside suppliers.


Outstanding share capital

Issued share capital less the par value of shares that are held in the company's treasury.


Outstanding shares

Shares that are currently owned by investors.


Path dependent option

An option whose value depends on the sequence of prices of the underlying asset
rather than just the final price of the asset.


Paydown

In a Treasury refunding, the amount by which the par value of the securities maturing exceeds that
of those sold.


Payout ratio

Generally, the proportion of earnings paid out to the common stockholders as cash dividends.
More specifically, the firm's cash dividend divided by the firm's earnings in the same reporting period.


Postponement option

The option of postponing a project without eliminating the possibility of undertaking it.


Priced out

The market has already incorporated information, such as a low dividend, into the price of a stock.


Put an option

To exercise a put option.


Put option

This security gives investors the right to sell (or put) fixed number of shares at a fixed price within
a given time frame. An investor, for example, might wish to have the right to sell shares of a stock at a certain
price by a certain time in order to protect, or hedge, an existing investment.


Quality option

Also called the swap option, the seller's choice of deliverables in Treasury Bond and Treasury
note futures contract. Related: cheapest to deliver issue


Split-fee option

An option on an option. The buyer generally executes the split fee with first an initial fee,
with a window period at the end of which upon payment of a second fee the original terms of the option may
be extended to a later predetermined final notification date.


Stock index option

An option in which the underlying is a common stock index.


Stock option

An option in which the underlying is the common stock of a corporation.


Stockout

Running out of inventory.


Take-out

A cash surplus generated by the sale of one block of securities and the purchase of another, e.g.
selling a block of bonds at 99 and buying another block at 95. Also, a bid made to a seller of a security that is
designed (and generally agreed) to take him out of the market.


Target payout ratio

A firm's long-run dividend-to-earnings ratio. The firm's policy is to attempt to pay out a
certain percentage of earnings, but it pays a stated dollar dividend and adjusts it to the target as base-line
increases in earnings occur.


Tax deferral option

The feature of the U.S. Internal Revenue Code that the capital gains tax on an asset is
payable only when the gain is realized by selling the asset.


Tax-timing option

The option to sell an asset and claim a loss for tax purposes or not to sell the asset and
defer the capital gains tax.


Time value of an option

The portion of an option's premium that is based on the amount of time remaining
until the expiration date of the option contract, and that the underlying components that determine the value of
the option may change during that time. Time value is generally equal to the difference between the premium
and the intrinsic value. Related: in-the-money.


Timing option

For a Treasury Bond or note futures contract, the seller's choice of when in the delivery month to deliver.


Top-down equity management style

A management style that begins with an assessment of the overall
economic environment and makes a general asset allocation decision regarding various sectors of the financial
markets and various industries. The bottom-up manager, in contrast, selects the specific securities within the
favored sectors.


Two-state option pricing model

An option pricing model in which the underlying asset can take on only two
possible (discrete) values in the next time period for each value it can take on in the preceding time period.
Also called the binomial option pricing model.


Virtual currency option

A new option contract introduced by the PHLX in 1994 that is settled in US$ rather
than in the underlying currency. These options are also called 3-Ds (dollar denominated delivery).


 

 

 

 

 

 

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