DEFINITION of Asian Tail
An Asian tail is an option feature whereby the Asian (averaging) feature is only active for a part of the option's life - typically the latter part. In an Asian option (or, average price option), the option holder is paid out if the average price of the underlying security trades above the pre-established strike price (for a call) or below for a put. This method of averaging the level of the underlying protects the investor from volatility, such as sudden and adverse price movements that can make an option finish out of the money, and thus worthless, upon expiration. 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.
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. 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.
BREAKING DOWN Asian Tail
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 (ELNs), 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 to 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.
Example of an Asian Tail
Suppose a company issues warrants to its employees that vest after 2-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 and today the stock is trading at $40 in the market. Over the 2-year period, the company exhibits strong growth and the price of the stock rises steadily to $60. However, one week before the warrants mature an accounting scandal rocks the company's main competitor, sending the share prices of the entire sector down with it, with this company's stock falling as low as $37. An Asian tail that averaged the last 30 days of the warrant's term would mute the negative effect of that increased volatility.