Barrier Hit Probability

One of the key features of many structured products is the presence of barriers, which are predefined levels that, when reached, can trigger changes in the product’s payoff or risk structure.

By employing Monte Carlo simulations, they can better quantify the likelihood of barrier breaches and make well-informed decisions

The Barrier Hit Probability (BHP) is a crucial metric that quantifies the likelihood of a barrier being touched by the underlying asset during the investment period. What is the concept of BHP, its calculation using Monte Carlo simulations, and the implications of barrier breaches in yield enhancement and participation products ? Barrier Hit Probability and Monte Carlo Simulation. The BHP is calculated using sophisticated valuation models that take into account the current market data and the dynamics of the underlying asset. One of the most popular methods for estimating BHP is the Monte Carlo simulation, a statistical technique that generates a large number of random scenarios for the asset’s price path. By simulating thousands or even millions of possible paths, the model can estimate the probability of the underlying asset touching the barrier level during the investment period. The Monte Carlo simulation method is particularly useful for structured products with complex payoffs or multiple underlyings, as it can account for the intricate relationships between the assets and market variables. The BHP derived from the model helps investors and issuers understand the risks associated with the structured product and make more informed decisions about their investments. Barrier Breach and its Implications. Barrier Level In the context of structured products, a barrier breach occurs when the underlying asset’s price touches the predefined barrier level. This breach can have significant consequences for the product’s payoff diagram and risk profile. For yield enhancement and participation products (corresponding to product categories 12 and 13 of the SSPA Swiss Derivative Map©),What are the derivative maps produced by EUSIPA and SSPA? the Barrier Level serves as the conditional capital protection level. If the barrier is breached, the risk buffer is exhausted, and the conditional capital protection is lost. When the barrier breach occurs, the structured product’s ability to participate in falling prices and its conditional capital protection are no longer available. If the price of the underlying asset is below the Strike Level at expiry, the product’s settlement will depend on the specified settlement type. This could involve the delivery of the underlying asset at the Strike Level or a cash settlement based on the asset’s price at expiry. Types of Barrier Observation. Choosing between American and European barrier options in Structured Products. There are two main types of barrier observation methods: barrier observation at daily close and barrier observation on expiry (also known as European Barriers).

1. Barrier Observation at Daily Close

In the case of a barrier observation at daily close, the daily closing prices of the underlying asset are considered for determining a barrier touch. This type of observation takes into account market fluctuations throughout the investment period and is generally considered more conservative than barrier observation on expiry. The barrier touch probability is higher with daily close observation since there are more data points to monitor for potential breaches.

1. Barrier Observation on Expiry (European Barriers)

With barrier observation on expiry, only the price of the underlying asset at expiry is relevant for determining a barrier touch. This approach simplifies the barrier monitoring process and can result in a lower barrier hit probability compared to daily close observation. However, this method can also expose investors to higher risks, as a single large price movement at expiry can trigger a barrier breach without any previous indication. The Barrier Hit Probability is a critical metric for understanding the risks and opportunities associated with structured products featuring barriers. By utilizing sophisticated valuation models, such as Monte Carlo simulations, investors and issuers can better assess the likelihood of a barrier breach and make informed investment decisions.