Asian Option

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Definition: Asian Option


Asian Option

Quick Summary of Asian Option


An option whose expiration value depends on the average value of an underlier over a specified period.




What is the dictionary definition of Asian Option?

Dictionary Definition


An Asian option also called the average value option is a name given to a special type of options contract. The average underlying price over some pre-set period of time determines the payoff for Asian options. This is quite different from the case of the usual European option and American option, where the price of the underlying instrument at maturity determines the payoff of the option contract.


Full Definition of Asian Option


An Asian option (also called an average option) is an option whose payoff is linked to the average value of the underlier on a specific set of dates during the life of the option. There are two basic forms:

An average rate option (or average price option) is a cash-settled option whose payoff is based on the difference between the average value of the underlier during the life of the option and a fixed strike.

An average strike option is a cash-settled or physically settled option. It is structured like a vanilla option except that its strike is set equal to the average value of the underlier over the life of the option.

Both forms can be structured as puts or calls. Exercise is generally European, but it is possible to specify early exercise provisions based upon an average-to-date. Averages can be calculated arithmetically or geometrically.

David Spaughton tells the story of how Asian options got their name. He and Mark Standish worked for Bankers Trust in 1987. They were in Tokyo on business when they developed the first commercially used pricing formula for options linked to the average price of crude oil. Because they were in Asia, they called the options “Asian options.” (see Falloon and Turner (1999))

End-users of commodities or energies tend to be exposed to average prices over time, so Asian options may appeal to them. Asian options are also popular with corporations, such as exporters, who have ongoing currency exposures. Asian options are also attractive because they tend to be less expensive—sell at lower premiums—than comparable vanilla puts or calls. This is because the volatility in the average value of an underlier tends to be lower than the volatility of the value of the underlier. Also, in situations where the underlier is thinly traded or there is the potential for its price to be manipulated, an Asian option offers some protection. It is more difficult to manipulate the average value of an underlier over an extended period of time than it is to manipulate it just at the expiration of an option.

Exact analytic formulas for average rate options don’t exist. This is primarily due to the fact that the arithmetic average of a set of lognormal random variables has a distribution that is largely intractable. Analytic approximations have been proposed by: Turnbull and Wakeman (1991), Levy (1992), and Curran (1992). If the underlier is assumed lognormal, then its geometric average is lognormal. In a classic paper, Kemna and Vorst (1990) use this fact to derive an analytic solution for the price of a geometric average rate option. They use that solution as a control variate for a Monte Carlo solution for the price of an arithmetic average rate option. See also Wilmott, Dewynne, and Howison (2000) and Seydel (2002) for numerical solutions based on exact differential equations. Tavella and Randell (2000) focus specifically on finite differences. Klassen (2001) discusses the use of binomial methods.

One advantage that is offered by the Asian options is that the risk of market manipulation of the underlying instrument at maturity is reduced by them.

Payout of Asian Call Options with Arithmetic Average

Below I have described the payout of some Asian call options.

For the continuous case, we have the payout

where

time to maturity is denoted by T, the price is denoted by S and, the strike price is denoted by K.

For the case of discrete monitoring (having monitoring at the times ) we have the payout

There is the existence of Asian options by which geometric average, as well as the arithmetic average, is used.

Pricing of Asian Options

There is a discussion of the problem of pricing Asian options using the Monte Carlo methods that are given in a paper by Kemna and Vorst.

The pricing problem has been solved by Rogers and Shi with a PDE approach.

When pricing Asian style options, the Variance Gamma model can be efficiently implemented. Then while we are pricing this type of option than using the Bondesson series representation for generating the variance gamma process has shown to have some advantages.


Synonyms For Asian Option


Average Option


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Definition Sources


Definitions for Asian Option are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 30th December, 2021 | 2 Views.