Average Strike Option
What Is an Average Strike Option?
An average strike option is a type of option where the strike price relies upon the average price of the underlying asset over a predetermined period of time. The payoff is the difference between the price of the underlying at expiry and the average price (strike). Average strike options are otherwise called Asian options.
Grasping an Average Strike Option
With an average strike option, the strike price sets at maturity, in view of the average price of the underlying. This is not quite the same as an American or European option, where the strike price is known at the hour of the initial purchase.
For an average strike call option to be in the money (ITM), the underlying asset's price must be over the average price (strike) at expiration. For a put option to be ITM, the underlying's price must be below the average price (strike) at expiration.
How the average is calculated must be determined in the options contract. Typically, the average price is a geometric or arithmetic mean of the price of the underlying asset. The data points are taken at pre-determined stretches, called trimmings, which are additionally determined in the options contract. Different averaging strategies, or the number of data points, will influence the average price. Hence, it's important to comprehend how the averaging will be calculated.
Average strike options have lower volatility than standard American or European options due to the averaging mechanism. This means they are typically less expensive than a comparable American or European option. They are utilized by traders who need exposure to an average price, or that have exposure to an underlying product, similar to a commodity for a while, and subsequently believe an average price option should cover that commodity for that period of time.
Utilizes for Average Strike Options
Average strike options are exotic options, and assist traders with tracking down answers for issues that normal options may not.
A trader or business might utilize an average strike option if:
- They need an average exchange rate or price over the long haul.
- They feel the average price is less subject to short-term manipulation around the expiry, which standard options might be presented to.
- They need to diminish the volatility of the option by utilizing an average.
- They need an average price for a thinly traded underlying market since pricing in the underlying market might be inefficient from one day to another, however more stable while averaging the price after some time.
Average Strike Option Example
On November first, a trader purchases a 90-day arithmetic average strike call option on stock ABCDE. The stock right now trades at $50 and averaging depends on the value of the stock after every 30-day period.
The stock price following 30, 60, and 90 days is $48, $53, and $56 and the arithmetic average price of the underlying is ($48 + $53 + $56)/3 = $52.33. The profit is the price of the underlying at expiry less the average price (strike). Accept the stock is trading at $54.50 at expiry. $54.50 - $52.33 = $2.17 or $217 per 100 share contract.
On the off chance that the underlying's price at expiry is below the average price (strike) the call option is out of the money (OTM). Alternately, on the off chance that the price at expiry is over the average price (strike) the call option is ITM. For a put option, on the off chance that the underlying is below the average price (strike) the option is ITM, and it is OTM assuming that the underlying's price is over the average price (strike).
Assuming that the option is OTM, the loss is limited to the premium paid for the option.
Features
- The strike price for an average strike option is set at expiry in view of the average price over the option's life.
- While buying an average strike option, the risk is limited to the premium paid.
- The payoff for an average strike call is the price of the underlying at expiry less the average price (strike).
- The payoff for an average strike put is the average price (strike) less the underlying's price at expiry.
