Average Price or Rate Option (APO, ARO)

Monthly Observations for an Average Price or Asian Option
Typical Premium Comparisons: Standard Option, Strip of Standard Options, Average Rate Option
An option whose settlement value is based on the difference between the strike and the average price (rate) of the underlying on selected dates over the life of the option, or over a period beginning on some start date and ending at expiration. The theoretical value of an average price or rate call will usually be less than the value of an otherwise identical standard option because the average price option acts like an option with a shorter expected life. The premium on an average price or rate option also will tend to be less than the combined premiums of a strip of options expiring on each measurement date, because prices or rates on the wrong side of the strike will reduce the average price or rate and, hence, the expected settlement value of the option. With a strip, observations on the wrong side of the strike would make one piece of the strip worthless but would not drag down the value of the others. Also called Asian Option, Currency Average Rate Option. See also Average Strike Rate Option (ASRO), Average Rate Cap, Compound Average Rate Option. See also Exotic Options, Path-Dependent Option, Strip, Weighted Average Rate/Price Option (WARO).

Glossary * A