Average Rate Option - ARO

DEFINITION of 'Average Rate Option - ARO'

An option used to hedge against fluctuations in exchange rates by averaging the spot rates over the life of the option and comparing that to the strike price of the option. Average rate options are typically purchased for daily, weekly or monthly time periods. Upon maturity, the average of the spot prices is compared to the strike price. If the average rate is less favorable than the strike price, the option issuer will pay the difference. If the average rate is more favorable then the option will expire worthless with no payment being made.


Average rate options are often used by companies that receive payments over time that are denominated in a foreign currency.

BREAKING DOWN 'Average Rate Option - ARO'

For example, a U.S. manufacturer agrees to import materials from a Chinese company for 12 months, and pays the supplier in yuan. The monthly payment is 50,000 yuan. The manufacturer budgets for a particular exchange rate, and purchases an ARO that matures in 12 months to hedge against the exchange rate falling below the budgeted level. At the end of each month, the manufacturer purchases 50,000 yuan on the spot market to pay the supplier. Upon maturity of the ARO, the strike price of the ARO is compared to the average rate that the manufacturer has paid for the purchase of 50,000 yuan. If the average is lower than the strike, the option issuer will pay the manufacturer the difference between the strike price and average price.




RELATED TERMS
  1. Average Strike Option

    A type of Asian option in which the strike price is based on ...
  2. Strike Price

    The price at which a specific derivative contract can be exercised. ...
  3. Average Price Put

    A type of option where the payoff depends on the difference between ...
  4. Bear Call Spread

    A type of options strategy used when a decline in the price of ...
  5. Deep Out Of The Money

    An option with a strike price that is significantly above (for ...
  6. Near The Money

    An options contract where the strike price is close to the current ...
Related Articles
  1. Forex

    Forex Options

    Stocks are not the only securities underlying options. Learn how to use FOREX options for profit and hedging.
  2. Professionals

    Incentive Stock Options

    CFP Online Study Guide - Employee Benefits Planning - Incentive Stock Options
  3. Options & Futures

    What's the Strike Price?

    The strike price is the price at which a derivative can be exercised, and refers to the price of the derivative’s underlying asset. In a call option, the strike price is the price at which the ...
  4. Professionals

    Alternative Investments

    Alternative Investments
  5. Options & Futures

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  6. Options & Futures

    Options Pricing: A Review Of Basic Terms

    The following is intended as a review of basic option terminology, which can be used as a reference as needed: American Options - An option that can be at any point during the life of the contract. ...
  7. Professionals

    Options

    Options
  8. Options & Futures

    Options Basics: How To Read An Options Table

    Sponsor: At last, an easy way to predict stock trends – get your FREE copy of 5 Chart Patterns You Need to Know. By Jay Kaeppel As more and more traders have learned of the multitude of ...
  9. Professionals

    European vs. American Options and Moneyness

    CFA Level 1 - European Vs. American Options and Moneyness. Differentiates European and American options and contrasts the concepts of instrinic and time value. Also discusses the moneyness of ...
  10. Professionals

    Exchange Traded Options

    CFA Level 1 - Exchange Traded Options. Contrasts over the counter options from those traded on the exchange. Discusses the characteristics of many exchange traded options.
RELATED FAQS
  1. How does the term 'in the money' describe the moneyness of an option?

    Find out what in the money means about the moneyness of call or put options and what it indicates about the relationship ... Read Answer >>
  2. How do I set a strike price for an option?

    Learn about the strike price of an option and how to set a strike price for call and put options depending on risk tolerance ... Read Answer >>
  3. What is the difference between in the money and out of the money?

    Learn about how the difference between in the money and out of the money options is determined by the relationship between ... Read Answer >>
  4. Can an option have a negative strike price?

    The simple answer is that, at least when it comes to exchange traded options, an option can't have a negative strike price ... Read Answer >>
  5. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  6. How do I set a strike price in a put?

    Learn about put options, considerations to make before you select strike prices and how to select strike prices for your ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center