Average Rate Option - ARO

AAA

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.

INVESTOPEDIA EXPLAINS '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. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  2. Hedge

    Making an investment to reduce the risk of adverse price movements ...
  3. Option

    A financial derivative that represents a contract sold by one ...
  4. Strike Price

    The price at which a specific derivative contract can be exercised. ...
  5. Spot Price

    The current price at which a particular security can be bought ...
  6. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
Related Articles
  1. Forex Fundamentals

    What Causes A Currency Crisis?

    Find out what can cause a currency to collapse, and what central banks can do to help.
  2. Options & Futures

    Hedging Basics: What Is A Hedge?

    This strategy is widely misunderstood, but it's not as complicated as you may think.
  3. Forex Education

    How To Profit From Interventions In The Forex Market

    The forex market can be extremely profitable. Learn how to spot an intervention and trade when it's occurring.
  4. Forex Education

    Global Trade And The Currency Market

    Learn how the Bretton Woods system got the ball rolling for world trade.
  5. Active Trading

    How Companies Use Derivatives To Hedge Risk

    Derivatives can reduce the risks associated with changes in foreign exchange rates, interest rates and commodity prices.
  6. Bonds & Fixed Income

    6 Factors That Influence Exchange Rates

    Find out how a currency's relative value reflects a country's economic health and impacts your investment returns.
  7. Options & Futures

    What are the most common momentum oscillators used in options trading?

    Read about some of the most common technical momentum oscillators that options traders use, and learn why momentum is a critical concept for options trading.
  8. Options & Futures

    How are Bollinger Bands® used in options trading?

    Use Bollinger Bands to identify volatility changes and place options trades at the right time; profit in bull or bear markets using these strategies.
  9. Options & Futures

    Stock Futures vs Stock Options

    A full analysis of when is it better to trade stock futures vs when is it better to trade options on a particular stock. A quick overview of how each of them works and why would a trader, investor, ...
  10. First time stock investors may ask, is there any way to buy insurance on stocks to prevent losses?
    Options & Futures

    Stock Safety: Top 3 Ways to Limit Your Losses

    First time stock investors may ask, is there any way to buy insurance on stocks to prevent losses?

You May Also Like

Hot Definitions
  1. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  2. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  3. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  4. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
  5. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  6. Law Of Supply And Demand

    A theory explaining the interaction between the supply of a resource and the demand for that resource. The law of supply ...
Trading Center