Average Price Call
What Is an Average Price Call?
An average price call is a call option whose profit is determined by contrasting the strike price with the average price of the asset that happened during the option's term. Therefore, for a three-month average price call, the holder of the option would receive a positive payout on the off chance that the average closing price for the underlying asset traded over the strike price during the three-month term of the option.
Paradoxically, the profit for a traditional call option would be calculated by contrasting the strike price to the price happening on the specific day when the option is exercised, or at the contract's expiration in the event that it remains unexercised.
Average price call options are otherwise called Asian options and are viewed as a type of exotic option.
Understanding Average Price Calls
Average price call options are part of a more extensive category of derivative instruments known as average price options (APOs), which are sometimes likewise alluded to as average rate options (AROs). They are mostly traded OTC, but a few exchanges, for example, the Intercontinental Exchange (ICE), likewise trade them as listed contracts. These sorts of exchange-listed APOs are cash-settled and must be exercised on the expiration date, which is the last trading day of the month.
A few investors favor average price calls to traditional call options since they reduce the option's volatility. Since volatility improves the probability that an option holder will actually want to exercise the option during its term, this means that average price call options are generally more affordable than their traditional counterparts.
The complement of an average price call is a average price put, in which the payoff is positive assuming that the average price of the underlying asset is not exactly the strike price during the option's term.
Real World Example of an Average Price Call
To illustrate, assume you accept that interest rates are set to decline and therefore wish to hedge your exposure to Treasury bills (T-bills). Specifically, you wish to hedge $1 million worth of interest rate exposure for a period of one month.
You start thinking about your options and see that T-charge futures are currently trading in the market at $145.09. To hedge your interest rate exposure, you purchase an average price call option whose underlying asset is T-bill futures, in which the notional value is $1 million, the strike price is $145.00, and the expiration date is one month in the future. You pay for the option with a $45,500 premium.
One month later, the option is about to lapse and the average price of the T-bills futures over the previous month has been $146.00. Realizing that your option is in the money, you exercise your call option, buying for $145.00 and selling at the average price of $146.00. Since the average price call option had a notional value of $1 million, your profit is $954,500, calculated as follows:
Alternatively, if the average price of T-bills over this period had been $144.20 instead of $146.00, then the option would have expired worthless. In that scenario, you would have encountered a loss equivalent to the option premium, or $45,500.
Highlights
- This is against standard call options whose payoff relies upon the price of the underlying asset at a specific point in time - at exercise or expiry.
- Otherwise called Asian options, average price options are utilized when hedgers or speculators are interested in smoothing the effects of volatility and not depend on a single point of time for valuation.
- Average price calls are a modification of a traditional call option where the payoff relies upon the average price of the underlying asset over a certain period.
