What Is an Asian Tail?

An Asian tail is a feature whereby an Asian option's averaging feature is only active for a part, usually the last ten to twenty days, of that option's life.

Key Takeaways

  • An Asian tail is a feature whereby an Asian option's averaging feature is only active for a part, usually the last ten to twenty days, of that option's life.
  • An Asian tail insures the holder specifically against last-minute fluctuations in the asset price, which is in contrast to an "Asian nose," where the averaging feature is only active during the beginning of an option's life.
  • The length and timespan of the Asian tail is negotiated and established at the beginning of the options contract.

Understanding Asian Tails

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.

Unlike a regular Asian option, the Asian tail describes an option where the Asian feature is only active for part of the option’s life—often the last part (as in pension plans and "guaranteed equity" products). This insures the holder specifically against last-minute fluctuations in the asset price. The length and timespan of the Asian tail is 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. This is in contrast to an Asian nose feature, in which the averaging feature is only active during the beginning of an option's life.

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 European style option for a good first approximation. Asian tails are fairly straightforward to value. You solve for it as an Asian option while the Asian feature is active and as a normal European option when it is not.

Asian Tail Example

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, which drags 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 extreme negative effect of that increased volatility.