WalkawayOption

A walkaway option is a type of exotic option offered in some over-the-counter markets. It provides the holder with the right to terminate the contract at one or more predetermined walkaway dates or when specific price levels are reached, thereby ending further exposure and any future payoffs.

Mechanics and structure typically combine a standard option payoff with an embedded walkaway feature. If the walkaway condition is triggered, the contract terminates at a predefined settlement, which may be the option’s current intrinsic value, a fixed amount, or zero, depending on the contract terms. If the walkaway condition is not met, the option behaves like a conventional option up to its expiry, at which point the standard payoff is realized. A common design is a walkaway call or put with a single walkaway date and a barrier or price level that governs termination.

Valuation of walkaway options is more complex than plain vanilla options because it is path-dependent and depends on the probability of the walkaway trigger. Pricing generally uses risk-neutral methods, including Monte Carlo simulation and lattice models, to account for multiple potential exit points, barrier levels, and correlations with dividends or interest rates. The instrument is typically bespoke, leading to limited liquidity and significant model and counterparty risk.

Use cases include hedging against unfavorable price paths while retaining upside exposure if conditions do not trigger termination. Variants may allow multiple walkaway dates or different termination rules, making the contract highly tailored to specific risk tolerances and market views.

See also: barrier option, Bermudan option, lookback option, American option, exotic option.