Asian Option

An Asian option is a type of option contract in which the payoff depends on the average price of the underlying asset over a certain period as opposed to the traditional options (American and European), where the payoff depends on the price of the underlying asset at a specific point in time (expiration).

There are two types of Asian options:

1. Average price option: The payoff of such an option depends on the difference between the average price of the underlying and the strike price. If the asset's average price over the term of the option is higher than the strike price (in the case of a call), or lower than the strike price (in the case of a put), the option will yield a payoff.

1. Average strike option: The payoff of such an option depends on the difference between the price of the underlying at maturity and a strike price that is defined as the average price of the underlying over the life of the option.

Asian options are commonly used by commodities traders who want to limit their exposure to price volatility. Due to averaging, Asian options reduce the risk of market manipulation of the underlying asset at maturity.

The benefits of Asian options include lower volatility, reduced costs, and protection against market manipulation. However, it can also be seen as a disadvantage as it doesn't provide unlimited profit potential as traditional options do. For example, even if the underlying asset's price rises significantly, the average price might be lower, leading to a lower return.

An example of an Asian option in practice could be an oil producer that wants to hedge against the future price changes of oil. Using an Asian option, they can mitigate the risk of extreme price changes in the oil market.

See Also

• Business Value