Forward option. Quick Reference
Forward Option See the same at the new domain: fincyclopedia. An option whose underlying is a forward contract. This option gives the holder the right to enter into a forward contract whereby he can buy or sell a specific underlying asset at a certain future time for a certain price determined in the forward contract. In a forward option, the contract specifies a period of time, rather than a certain date, during which the holder will exercise his right to trade the forward option. The forward option is, in essence, an agreement to trade in the future for a fixed price set today.
A forward start option is an exotic option that is purchased and paid for now but becomes active later with a strike price determined at that time. The activation date, expiration date, and underlying asset are fixed at the time of purchase. A series of forward start options is called a reviews of the dealing center or ratchet option.
Each option becomes active when the previous option in the series expires and each strike also sets at the time of activation. Key Takeaways A forward strike option is an exotic option similar to a vanilla option, except the forward start option doesn't activate until some time in the future and the strike price is unknown when the option is bought. All parameters are set for the forward option at initiation not activation except forward option the strike price.
The strike price is unknown at initiation but is typically set to be at- or near-the-money when the option activates. Once the option activates and its strike is set, the option is valued in the same way as a vanilla option.
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A series of forward start options is called a ratchet or cliquet. Understanding the Forward Start Option At forward option, a forward start option contract spells out all the defined characteristics relevant to the option, except for its strike price. The expiration date, the underlying asset, size, and activation date are set at the time the contract is drawn up. The only unknown for the contract is the strike price. In terms of pricing the contract, the future price of the underlying asset is also unknown.
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The contract typically stipulates some parameters for where the strike price will be in relation to the underlying asset's price. Since it is a customized contract, they can negotiate any terms they want.
Forward start options typically attempt to keep future strike prices at the money or near the money. In this way, the holder will have the right, but not the obligation, to buy call or sell put the underlying asset in the future at or near the then-current market price. Knowing where the strike price will be in relation to the underlying's price makes it easier to come up with the premium cost of the option, which is also typically determined and paid at the initiation of the contract prior to the activation date.
If at the expiration date, the underlying trades below the strike price of the option for a call then it expires worthless. Forward option the underlying is above the strike for a callthen the holder exercises it and owns the underlying at the strike price.
For a put option, if the underlying is below the strike price, the option has value and will be sold or exercised to realize a gain. If the underlying is above the strike price, the option will expire worthless. Typically, as with most options, the holder may sell the option if it is in the money and take the cash instead of exercising the option.
Since it is an exotic option, the seller and buyer of the option may also agree to settle the option with cash instead of delivering the underlying. Once a forward start option becomes active strike price is set then the option is valued like a vanilla option.
Employee stock options are a type of forward start option. Here, the company commits to granting at-the-money options to employees without knowing what the stock price will be in the future.
Cliquets A group of consecutive forward start options is called a ratchet option or cliquet option. In this instance, the first forward start option is active immediately, and each successive forward start option becomes active when the previous one expires. When the first option in the series matures, the next option becomes active as it gets its strike price.
If at the end of the next settlement the underlying trades above the new strike for a callthe holder may elect to receive the difference between the price of the underlying and the strike, or exercise the option and receive the underlying.
Example of a Forward Start Option Forward start options are exotic and therefore customized by the people who trade them. Since they are not listed forward option an exchangea hypothetical example is required for demonstration purposes. Assume that two parties agree to enter into a call forward start option on Netflix Inc.
Forward start option
NFLX stock. It is September and they agree that the forward start option will activate on January 1 at-the-money. That means on January 1 the strike price for the option will be the price that stock is trading at on that day.
The option will expire in Forward option.
The exact strike price is unknown, but the parties do know the strike and underlying's price will be the same at activation. They can look at current 6-month options January to June and forward option volatility to determine a premium for the option.
They agree to trade one contract, equivalent to shares of the underlying stock. To make money on the call, the price of the underlying needs to move above the strike price plus the premium. Compare Accounts.