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 whose price is based on an asset’s average price over time rather than its spot price at expiration. In average strike options, the strike price is based on the average price of the underlying asset over a set period, rather than being fixed at the outset.

Asian options can help mitigate price volatility, making them useful for businesses managing currency or commodity risks. Lower price volatility also means they tend to be less expensive than standard options.

What Is an Asian Option?

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

American and European options allow holders to exercise an option at a predetermined strike price. The key difference between them is timing: American options can be exercised anytime before expiration, while European options are only 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 only on the expiration date.

The specific terms of an Asian option, such as the averaging period and method, are negotiable. There are two different types of Asian options: average strike options and average price options.

Average strike options are issued with an unknown strike price, which is determined based on the average price of the underlying asset at selected time intervals.

Average price options, conversely, are issued with a known strike price, but an unkown payoff. With these, the payoff is determined at expiration, based on the average price of the underlying asset over a period of time. Both types of Asian options may be priced according to arithmetic or geometric averages.

Who Buys Asian Options?

Asian options are commonly used by businesses that deal with price-sensitive goods or currencies. These options buyers are often in sectors like energy, agriculture, and international trade — areas where prices can swing sharply due to market volatility or seasonal fluctuations.

Because Asian options can help smooth out short-term price spikes, they can help protect against rate manipulation, inefficient pricing in thinly traded markets, or sudden shifts in currency exchange rates.

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 at expiration. Unlike standard options, the price of an Asian option is determined by the average price of the underlying asset over a specified period, rather than the spot price at expiration.

The way the average price is calculated in an Asian option, such as the averaging method and time intervals, is defined by the contract. It’s common for Asian options to define average either as an arithmetic or geometric mean over a period of time (e.g., 30 days), which impacts pricing.

Maximum Payoff

Like standard options, the potential payoff for an Asian option depends on whether a trader is buying a call or a put option. Even though the prices of Asian options are determined by the average price instead of the spot price, the payoff structure for Asian options works in the same way.

For a call option buyer, the maximum payoff is theoretically unlimited, since there is no limit on how high the stock’s price can go. However, in practice, the payoff is usually constrained by the average price calculation over the option’s life.

For a put option buyer, the maximum payoff can be seen if the stock’s price declines significantly (or even goes to zero), though losses are generally capped at the initial investment.

Maximum Loss

Losses for buyers of Asian options are generally limited to the premiums paid at the initiation of the trade, making them a defined-risk strategy. Because of the average effect that reduces volatility, purchase premiums are often lower than those for standard options.

Breakeven

The breakeven price of an Asian option depends on the strike price of the option and the premium initially paid for the option. If a buyer paid $1.50 for a call option with a strike price of $50, the breakeven price would 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, the investor could earn a profit on the option investment.

The breakeven point for an average strike option is less predictable than for standard options, as it is not known until expiration. But it follows the same principle, as it is determined by the final strike price and the premium paid.

Pros and Cons of Asian Options

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

Asian Option Pricing

Because Asian options are priced based on an average price instead of the spot price at expiration, they experience relatively lower volatility and are generally less expensive than standard options. This is because averaging several price values over time may 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 as well.

How Asian Option Pricing Works

The pricing of Asian options is calculated using an average value, which can be determined through either an arithmetic or geometric mean. In practice, pricing the value of Asian options can be complex, requiring advanced calculations, but the following examples illustrate how these options work.

Asian Options Pricing Example – Average Price Option

Assume that an investor buys a 90-day call option with a strike price of $50. This option costs $1.25, and the average price is defined as the arithmetic mean of the underlying asset price taken every 30 days.

The stock has a price of $51.00, $48.50, and $52.00 at the 30, 60, and 90-day mark. The arithmetic mean of those three 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 (the calculated price at expiration minus the strike price, $50.50 – $50).

Because the investor purchased the option for $1.25, in this scenario, they would take a loss of $0.75 per share. Since one options contract typically covers 100 shares, this would result in a total loss of $75.

If the arithmetic mean were $53.00, the option would be worth $3.00 at expiration. After subtracting the $1.25 premium paid, the investor would gain $1.75 per share, ) or $175 total on a standard contract. 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

An investor buys a 90-day call option for a stock. This option costs $1.25, and the average strike price is defined as the arithmetic mean of the underlying asset price taken every 30 days.

The stock has a price of $51.00, $48.50, and $52.00 at the 30, 60, and 90-day mark. The arithmetic mean of those three 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 per share ($52.00 – $50.50).

Because the investor originally purchased the option for $1.25, in this scenario, they would have a gain of $0.25 per share. The value of the option at expiration is $1.50, and after subtracting the $1.25 premium paid, the net gain is $0.25 per share. Since one options contract typically covers 100 shares, this would result in a total profit of $25.

The Takeaway

Unlike standard options, which are valued based on the spot price of the underlying asset at expiration, Asian options are valued based on the average price of the underlying asset over a specified period before expiration.

Because the value of an Asian option is derived from an average of prices, it generally experiences less price volatility. Lower volatility generally leads to cheaper prices than standard options.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

FAQ

Are Asian options cheaper?

Asian options are often (but not always) cheaper than standard American or European options due to their lower volatility, which results from using an average price rather than the spot price at expiration. Because an average price is used, Asian options are generally less volatile, and typically cheaper as a result.

How are Asian options priced?

Rather than using the spot price at expiration, Asian options are priced using an average value, typically calculated using an arithmetic or geometric mean over time.

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 in the Black-Scholes model is that the stock’s price will move according to Brownian motion. Because arithmetically averaged Asian options do not follow the assumption of Brownian Motion, the standard Black-Scholes pricing model does not apply.

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