In this paper we will explain Asian Option, which is also termed as Average Option. David Spaughton and Mark Standish invented this method of pricing options. They belonged to Tokyo, Japan, that’s why the option is named as Asian option. It is available at a low cost, for which, the exporters like this.
An Asian option, also known as Average Option, is a kind of option whose payoff has a strong linkage with the underlier’s average value through a specific period during the entire option life. The tag Asian does not carry any special meaning. The two founders of Asian option, David Spaughton and Mark Standish, first invented the pricing formula for option trading. Since they belonged to Asia, the method is named as Asian Option.
The average can be calculated both arithmetically and geometrically. It can be weighted as well with some specific weights.
However, exact formula for the Asian option does not exist, for the arithmetic mean of a set of “lognormal random variables” has a highly intractable distribution. The Asian options are lucrative for the end users of energy or commodities, for they are usually exposed to average prices every now and then.
Those exporters, who are facing currency exposures, also like the Asian option. The Asian options are not highly expensive and they can be sold at a low premium compared to Vanilla Options.
Asian Options are of two types. One is average price option and the other is average strike option.
The payoff of the average price option depends on the difference between the option’s life and average underlier value.
On the other hand, an average strike option is basically a cash settled option. It is designed more like a Vanilla option but the average strike option is made equal to the underlier’s average value throughout the entire option period.