What happens to a knock-out option if the spot exchange rate hits a specific barrier?

A knock-out option is a type of exotic option that becomes void if the underlying asset (in this case, the spot exchange rate) breaches a predetermined barrier, known as the knock-out level. If the spot exchange rate hits this specific barrier, the knock-out option ceases to exist, rendering it worthless. This feature provides a level of risk management for the option seller but introduces additional risk for the option holder, as the option can be effectively eliminated before maturity if the market reaches the barrier.

The nature of knock-out options is such that they are designed to provide investors with a way to hedge risks while limiting their potential exposure. Therefore, when the barrier is breached, all rights associated with the option disappear, and the option holder loses the ability to exercise or benefit from any future price movements of the underlying asset.