What is the Average price path
The average price on the spot is a type of option where the payoff is determined by the difference between the exercise price and the average price of the underlying asset. If the average price of the underlying asset over a certain period of time exceeds the strike price the average price of a put, the buyer pays the option is equal to zero. Conversely, if the average price of the underlying asset is below the strike price of such a put, the payoff to the buyer of the option is positive and is equal to the difference between the exercise price and the average price.
Breaking down ‘the Average price the way
The average price of a put option example put option which gives the owner of an asset the right to sell the underlying asset at an agreed price by a certain date. Puts so-called because their owners have the option to put the asset for sale.
The average price of a put is considered an exotic option, since the payoff depends on the average price of the underlying asset over a certain period of time and not immediately assume the value of which depends on the price of the underlying asset at any given time. Like all options, average prices can be used for hedging or speculation, depending on whether the exposure to the underlying asset. Buyers average prices usually have a bearish view on the underlying asset or security.
An example of an average price put
Consider producers of oil and gas believes that the price of crude oil decreases, and therefore wishes to hedge. Suppose that the manufacturer wishes to hedge 100 000 barrels of crude oil for one month. Next, assume that oil is trading at $90 per barrel and the average price of a put with a strike price of $90 expiring in one month can be bought for $2.
After one month when the option expires if the average oil price of $85, the oil producer’s profit will be $300,000 (i.e., the difference of $ 5 between the strike price and the average price less the premium paid for the option premium x 100 000 barrels). Conversely, if the average oil price for one month is $93, the option expires unexercised. In this case, the loss for the hedge transaction will be equal to the cost of the option Premium, or $200,000.