What Are Asian Options and How Are They Priced?

By Dan Miller · March 21, 2023 · 7 minute read

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What Are Asian Options and How Are They Priced?

Asian options (also known as average strike options or average options) are a type of exotic option that is priced according to the average price of the underlying commodity, as opposed to the spot price.

Read on for how they’re priced, how they work, pros and cons, and more.

What Is an Asian Option?

Asian options are a type of exotic option that trade differently than standard American or European options.

American and European options allow the holder to exercise an option at a strike price known on the purchase date. They differ in when the option can be exercised.

American options can be exercised at any time up to and including the expiration date. European options can only be exercised on the expiration date.

Asian options, on the other hand, are priced based on the average price of the asset over a period of time and like European options they are exercised on the expiration date.

The various parameters of an Asian option are negotiable, but there are two different types of Asian options, average strike options and average price options.

Average strike options are sold with an unknown strike price. The strike price will be determined based on the average price of the underlying asset at selected time intervals.

Average price options are sold at a known strike price. The exercise price will be determined based on the average price of the underlying asset at selected time intervals.

In addition, both types of Asian options may be priced according to arithmetic or geometric averages.

Who Buys Asian Options?

Asian options are usually purchased to solve a particular business problem:

  1. A buyer wants to lock in an average price or exchange rate over a period of time.
  2. A buyer wants to protect against price manipulation in the market.
  3. A buyer wants to protect against volatility in the price movement of the underlying asset.
  4. A buyer wants to mitigate against inefficient pricing due to an asset being thinly traded.

How Asian Options Work

Like standard options, the price of a call or put in Asian options depends on the price of the underlying asset when the option expires. But unlike standard options, the price of an Asian option will depend on the average price of the underlying over a specified period of time.

Different kinds of Asian options will define average in different ways, so make sure that you check the details of the contract before investing. It’s common for Asian options to define average either as an arithmetic or geometric mean over a period of time.

One example might be for an Asian option to be priced as the arithmetic mean of the underlying stock’s price as measured every 30 days.

Maximum Payoff

Like standard options, the maximum payoff for an Asian option will depend on whether it is a call or put option. Even though the prices in an Asian option are determined by the average price instead of the spot price, the maximum payoff for Asian options works in the same way.

For a call option, the maximum payoff is unlimited, since there is no limit on how high the stock’s price can go.

For the purchase of a put option, the maximum payoff will be if the stock’s price goes to zero.

Maximum Loss

Losses on Asian options are limited to the premiums paid at initiation of the trade. Because of average pricing and lowering the volatility of large price swings, the purchase premiums are also typically lower than available with regular options.

Breakeven

The breakeven price of an Asian option depends on the strike price of the option and the amount of premium that you paid for the option originally. If you paid $1.50 for a call option with a strike price of $50. Your breakeven price in this scenario will be $51.50 (the strike price of 50 plus the $1.50 in premium paid originally).

If the stock’s average price when the option expires is above $51.50, you will earn a profit on the option investment.

It’s more complicated to know in advance what the breakeven will be on an Average strike option but the calculation is the same.

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Pros and Cons of Asian Options

Here are some of the pros and cons of trading with Asian options:

Pros

Cons

Less volatility than standard options due to the averaging of the price Not supported by all brokers
Generally less expensive than standard options due to lower volatility Lower liquidity than standard options
Useful for traders who have exposure to the underlying asset over time, like suppliers of commodities More complicated to price than standard options

Asian Option Pricing

Because Asian options are priced based on an average price instead of the closing price on the date of expiration, they experience lower volatility. This makes intuitive sense, since averaging several price values over time will tend to dampen out extreme values. Because volatility is a key measure of the price of an option, the lower volatility of Asian options generally means lower prices for options.

How Asian Option Pricing Works

The pricing of Asian options is calculated using an average value. Different types of Asian options calculate the average in different ways, and it’s important to understand how the average will be calculated before you purchase the contract. The two most common ways that an average is calculated with Asian options are the arithmetic mean and the geometric mean.

Asian Options Pricing Example – Average Price Option

On March 1, you buy a 90-day call option for stock XYZ with a strike price of $50. This option costs you $1.25 and the average price is defined as the arithmetic mean of the underlying asset price taken every 30 days.

XYZ has a price of $51.00, $48.50 and $52.00 at the 30, 60 and 90 day mark. The arithmetic mean of those 3 prices is ($51 + $48.50 + $52) / 3, or $50.50. Since the option has a strike price of $50, the option closes with a value of $0.50 (calculated price at expiration less spot price, $50.50 – $50).

Because you purchased the option for $1.25 originally, in this scenario you would take a loss on the position.

As with standard options, if the average price of the underlying asset is below the strike price (for a call option), the option expires worthless.

Asian Options Pricing Example – Average Strike Price Option

On March 1, you buy a 90-day call option for stock XYZ. This option costs you $1.25 and the average strike price is defined as the arithmetic mean of the underlying asset price taken every 30 days.

XYZ has a price of $51.00, $48.50 and $52.00 at the 30, 60 and 90 day mark. The arithmetic mean of those 3 prices is ($51 + $48.50 + $52) / 3, or $50.50. Therefore, at expiration the strike price will be $50.50. The option closes with a value of $1.50 (price at expiration less calculated spot price, $52 – $50.50).

Because you purchased the option for $1.25 originally, in this scenario you would have a gain on the position.

The Takeaway

Unlike standard options that are valued based on the spot price of the underlying asset when the option expires, Asian options are valued based on an average price taken in discrete time periods before expiration.

Because the value of an Asian option is based on an average of prices, there is less volatility in the prices. Lower volatility leads to generally cheaper prices than standard options.

If you’re ready to try your hand at online stock options trading, You can set up an Active Invest account and trade options from the SoFi mobile app or through the web platform.

And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commissions, and members have access to complimentary financial advice from a professional.

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FAQ

Are Asian options cheaper?

Asian options are usually (but not always) cheaper than standard American or European options. This is because Asian options are priced using an average price rather than the spot price of the underlying commodity on the date of expiration. Because an average price is used, this makes Asian options less volatile, and consequently, generally cheaper.

How are Asian options priced?

Rather than using the spot price of the underlying stock or commodity on the date of the option’s expiration, Asian options are priced using an average price over the preceding period of time. While there are different methods for calculating the average price, it’s usually calculated as either the arithmetic or geometric mean of the underlying stock or commodity.

Why can’t Black-Scholes models value Asian options?

The Black-Scholes pricing model is one of the most common ways to price standard American or European options. To price options, the Black-Scholes method makes a variety of assumptions about the price of the underlying stock. One assumption required by Black-Scholes is that the stock’s price will move following something called Brownian motion. Because arithmetically-priced Asian options do not follow Brownian Motion, the standard Black-Scholes pricing model does not apply.


Photo credit: iStock/Boris Jovanovic

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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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