Asian Option

An Asian option is an exotic option and is also called average-price option or average option. In Asian option, option payoff is dependent on the average price of the underlying asset, over a prespecified period, during the lifetime of the option. This is different from plain vanilla options like European and American options, where option payoff depends on the price of the underlying instrument at the time of exercise.

Asian option payoff can be calculated in two ways:

Average Price Options: The payoff at maturity is equal to the average price of the underlying asset over a specified time period minus the fixed strike price of the option.

Average Strike Options: The payoff is equal to the price of the underlying asset at maturity minus a variable strike, which is equal to the average price of the underlying asset over a specified time period.

Furthermore, the average price can be calculated using either the arithmetic or the geometric mean.

One of the advantages of Asian options is that it reduces the volatility associated with the options and thus it is relatively less costly compared to its American and European counterpart.