Asian Options

An Asian option, also called an average price or average rate option, has a payoff based on the average price of the underlying over a set period rather than the price on one day. A one year Asian call on crude oil might pay the amount by which the average daily settlement price over the year exceeds the strike. Averaging reduces the effect of short term swings and manipulation near expiry, which makes Asian options cheaper than standard options and a natural fit for businesses whose exposure builds up over time.

The name#

The term is often traced to Bankers Trust traders working in Tokyo in 1987, who priced options on the average price of crude oil. The name stuck even though the product has nothing specifically Asian about it.

Types of Asian options#

Most traded Asian options use arithmetic averages of daily or monthly prices, matching how businesses actually incur costs.

Why Asian options are cheaper#

The average of prices over a period moves less than the price at a single point, so the effective volatility is lower. For an average over the whole life of the option, effective volatility is roughly the underlying volatility divided by √3 under simple assumptions, about 58% of it.

Who uses Asian options#

• Airlines and transport companies hedging average fuel costs over months. See Crude Oil.
• Manufacturers buying metals or energy continuously. See Commodity Market Fundamentals.
• Exporters and importers hedging monthly currency flows.
• Commodity producers selling output throughout the year.

Many commodity swaps and options settle on monthly average prices for exactly these reasons, and exchanges such as CME list average price options on some energy and metals contracts.

Manipulation resistance#

Because the payoff depends on many observations, a short spike or drop near expiry has a small effect. This makes Asian options attractive in thin markets where a single closing price could be pushed around. See Market Manipulation.

Pricing#

• Geometric average options have closed form prices under Black Scholes assumptions, because the geometric average of lognormal prices is itself lognormal.
• Arithmetic average options have no exact closed form. Practitioners use Monte Carlo simulation (often with the geometric version as a control variate), moment matching approximations such as the Turnbull Wakeman method, or finite difference methods.

Greeks#

Once part of the averaging period has passed, the average is partly fixed, so the option's sensitivity to further moves falls. Delta and gamma shrink as the averaging period progresses, making hedging smoother than for standard options near expiry.

Common mistakes#

• Comparing Asian and vanilla premiums directly without considering the different payoffs.
• Mismatching averaging dates with actual exposure.
• Ignoring how the average is defined: source, frequency and treatment of holidays matter.

Frequently asked questions#

What is an Asian option?#

An option whose payoff depends on the average price of the underlying over a period, rather than the price at a single date.

Why are Asian options cheaper than regular options?#

Because the average price is less volatile than the price on a single day, which lowers the option's expected payoff.

Who uses Asian options?#

Mainly businesses with exposure spread over time, such as airlines, manufacturers and commodity producers.

Next, learn options paid in another currency in Quanto Options.