What it means
Most options pay out according to how far the price ends up from an agreed strike price. A double no-touch is different, because it pays a fixed sum or nothing.
The buyer picks two levels, and the option wins if the price never touches either one before the end date. The payoff is binary, which means it is all or nothing.
If the underlying price, such as an exchange rate, stays inside the range, the buyer receives the full agreed payout. If it touches the upper or lower level at any moment, the contract ends and the buyer loses the premium paid.
The premium reflects the chance of staying in range. A narrow range makes a payout unlikely, so the premium is low relative to the payout.
A wide range makes success more likely, so the premium is high, sometimes close to the payout itself. Traders and investors use the product to express a view that volatility, the size of price swings, will be low.
Some corporate treasurers use it to offset other positions that lose money when markets are turbulent. Banks that sell these options manage their risk with complex hedging, particularly as the price approaches a barrier.
The risks are clear, because a single spike in price, even for a brief moment or caused by a thin market, can wipe out the whole premium. Because definitions of a touch vary, the contract must say which price source and trading hours count.
Buyers should also understand that the chance of success is often lower than it seems. The double no-touch has a counterpart, the double one-touch, which pays if either barrier is touched.
Together they allow buyers to take a view on whether a market will be quiet or volatile. Both are traded over the counter, with terms agreed between a bank and its client.
In practice
Real-world examples.
Example
A currency trader expects a quiet market before a long holiday period. She buys a double no-touch with a range around current rates and a one-month expiry, hoping that prices will stay calm.
Example
A corporate treasury team has a position that benefits when currency swings are large. It buys a double no-touch to offset the cost if markets stay calm and the position gains little.
Example
A bank sells a double no-touch to a client and hedges its own exposure carefully. As the exchange rate approaches a barrier, the bank adjusts its hedges, because a touch would end its obligation.
Formula
Calculation
Profit if successful = payout - premium paid
Loss if unsuccessful = premium paid
Implied probability of success (approximate) = premium / payout
Worked example: A trader buys a double no-touch option on a currency pair. The payout is $100,000 if the exchange rate stays between 1.0500 and 1.1500 for three months. The premium is $30,000.
If the rate stays within the range for the whole period, the trader receives $100,000. Profit = $100,000 - $30,000 = $70,000.
If the rate touches either level at any time, the trader receives nothing. Loss = $30,000.
The approximate market-implied probability of success is $30,000 / $100,000 = 30%. The trader needs to believe that the true chance of staying in range is higher than 30% for the purchase to make sense. The rates and premium are hypothetical.Case study
Seen in the real world.
Northwind Treasury Services is a fictional advisory firm that helped a client buy a double no-touch on a currency pair. The client paid $20,000 for a $100,000 payout if the pair stayed inside a wide range for two months.
In this illustrative case, the pair stayed calm for seven weeks, then an unexpected central bank announcement pushed it through the upper barrier for a few minutes. The option expired worthless and the client lost the premium.
The client had not read the contract carefully and had assumed that only closing prices mattered. After the loss, the advisory firm introduced a checklist for exotic products, including price sources, trading hours and scenarios. The illustrative lesson is that fine print and event risk decide these trades.
Watch out
Common mistakes.
- Believing a market that is currently calm will stay calm. Scheduled events and surprises can cause sudden moves that touch a barrier.
- Ignoring the exact definition of a touch. A brief spike on a particular price source may count even if the market closes inside the range.
- Treating the premium as a small cost. If the barriers are tight, the chance of losing the whole premium is high.
Questions
People also ask.
What does no-touch mean?
It means the underlying price must not reach either barrier at any time during the life of the option.
How is it different from a normal option?
A normal option pays according to the final price, while a double no-touch pays a fixed sum or nothing depending on the price path.
Who buys double no-touch options?
Speculators who expect calm markets and some corporate treasurers who use them to offset other risks.
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