Jun 24

Asian option – 7 min screencast

by David Harper, CFA, FRM, CIPM

FRM |

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An Asian option is an important path-dependent type of exotic option. Eight variations:

  • Put or call
  • Take the average the spot or the strike price
  • Can use either arithmetic or geometric average

The key benefit is reduced basis risk compared to a plain-vanilla option. A typical option depends on the partially random values of the spot/strike price on the exercise date; it the option is used to hedge, this makes for greater basis risk. An Asian option addresses this by smoothing (averaging) either the spot or the strike price.

Because an Asian option has lower volatility, it is also cheaper (i.e., lower premium) than a plain vanilla option! Summary benefits:

  • Lower volatility implies lower option cost (premium)
  • Probably lower basis risk if options used to hedge (i.e., as less dependent on random values on date of exercise)

Screencast:

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