Asian Option

An Asian option is an option type where the payoff relies upon the average price of the underlying asset over a certain period of time rather than standard options (American and European) where the payoff relies upon the price of the underlying asset at a specific point in time (maturity). These options allow the buyer to purchase (or sell) the underlying asset at the average price rather than the spot price.

Asian options are otherwise called average options.

There are different ways of interpretting "average," and that should be determined in the options contract. Typically, the average price is a geometric or arithmetic average of the price of the underlying asset at tactful spans, which are likewise determined in the options contract.

Asian options have moderately low volatility due to the averaging mechanism. They are utilized by traders who are presented to the underlying asset throughout some time, for example, consumers and providers of commodities, and so on.

Breaking Down Asian Option

Asian options are in the "exotic options" category and are utilized to take care of specific business issues that ordinary options can't. They are developed by tweaking ordinary options in minor ways. Overall (however not dependably), Asian options are more affordable than their standard partners, as the volatility of the average price is not exactly the volatility of the spot price.

Commonplace purposes include:

1. At the point when a business is worried about the average exchange rate over the long haul.
2. Whenever a single price at a point in time may be subject to manipulation.
3. At the point when the market for the underlying asset is exceptionally unpredictable.
4. While pricing becomes inefficient due to thinly traded markets (low liquidity markets).

This type of option contract is alluring on the grounds that it will in general cost not exactly ordinary American options.

Asian Option Example

For an Asian call option involving arithmetic averaging and a 30-day period for sampling the data.

On Nov. 1, a trader purchased a 90-day arithmetic call option on stock XYZ with an exercise price of $22, where the averaging depends on the value of the stock after every 30-day period. The stock price following 30, 60, and 90 days was $21.00, $22.00, and $24.00.

The arithmetic average (mean) is (21.00 + 22.00 + 24.00)/3 = 22.33.

The profit is the average minus the strike price 22.33 - 22 = 0.33 or $33.00 per 100 share contract.

Likewise with standard options, in the event that the average price is below the strike price, the loss is limited to the premium paid for the call options.