Skip to content

FRM Part I · FRM Exam Part I · Exotic Options

A trader compares a European call option on the price of a stock at maturity with an arithmetic-average-price Asian call on the same stock, with the same strike, maturity and underlying. Assuming positive volatility and no dividends, which statement is correct?

The Asian call is generally cheaper than the comparable European call, because averaging prices lowers the volatility of the variable that determines the payoff, and option value rises with volatility.

  1. AThe Asian option is generally cheaper because averaging reduces the effective volatility of the payoff variableCorrect
  2. BThe Asian option is generally more expensive because averaging increases the chance of a large payoff
  3. CThe two options have identical values because the expected average equals the expected final price
  4. DThe Asian option is more expensive because it can be exercised at any averaging date

Explanation

Averaging prices over the option's life smooths out fluctuations, so the average has lower volatility than the terminal price. Lower volatility of the underlying payoff variable means a lower option value. Option 3 is wrong because the expected averages differ and the payoff is convex, so lower variance reduces value.

Did you get it right without looking?

One question tells you little. A timed set on Exotic Options shows your real accuracy, how long you take and where you lose marks.

Practise Exotic OptionsFree diagnostic mock

More Exotic Options questions