What Is an Asian Tail?

An Asian tail is an Asian option that bases its payout on the average price of the underlying in the last several days or weeks of the contract's life—usually the last ten to twenty days. This is in contrast to an Asian nose, another variant of an Asian option, where the averaging feature is only active during the beginning of an option's life.

Key Takeaways

  • An Asian tail is an option that pays out based on the average price of the underlying, but only based on the last several days or weeks of the contract's life.
  • An Asian tail protects against large price swings near expiration.
  • The length and timespan of the Asian tail are agreed to at the initiation of the contract.
  • An Asian nose, in contrast, averages only the beginning days' or weeks' prices of the option's life.

Understanding an Asian Tail

Unlike vanilla options, an Asian option's payout is based on the average price and not its closing price. With an Asian tail, this averaging is only relevant over the last days or weeks of the contract.

An Asian option, also known as an average price option, pays the option holder the average price of the underlying security's price movement even if the call option trades above, or the put option trades below, the pre-established strike price. This method of averaging the level of the underlying asset's price protects the investor from volatility, such as sudden and adverse price movements that can make an option finish out of the money (OTM), and thus worthless, upon expiration.

The Asian tail describes an option where the Asian feature is only active for the last part of the option’s life. This protects the holder against last-minute fluctuations in the asset price. The length and timespan of the Asian tail are negotiated and established at the beginning of the options contract, although conventionally the last ten to twenty days of an option's life is when the Asian tail kicks in.

Asian tails are specifically intended to protect hedgers against increased volatility that may occur toward the end of an option's lifespan. This kind of averaging is often built into long-term options, such as equity-linked notes (ELN), employee share options, warrants, or convertibles, to avoid or reduce price manipulation on expiry.

If the time to expiry is a year or more, traders often just treat it as a European-style option for a good first approximation. An Asian tail is fairly straightforward to value. It can be thought of as an Asian option while the Asian feature is active and a normal European option when it is not.

Example of an Asian Tail

Suppose a company issues warrants to its employees that vest after two years. These contracts give those employees the right, but not the obligation, to purchase shares in their company's stock at a strike price of $50 per share. The current price of that stock is $40 per share.

Over the two-year period, the company exhibits strong growth and the price of the stock rises steadily to $60 per share. However, one week before the warrants mature, an accounting scandal rocks the company's main competitor, sending the share prices of the entire sector sharply lower, and this company's stock down to $37 per share. An Asian tail that averaged the last 30 days of the warrant's term would mute the extremely negative effect of that increased volatility.