What Is an Average Price Call?

An average price call is a call option whose profit is determined by comparing the strike price to the average price of the asset that occurred during the option's term. Therefore, for a three-month average price call, the holder of the option would receive a positive payout if the average closing price for the underlying asset traded above the strike price during the three-month term of the option.

By contrast, the profit for a traditional call option would be calculated by comparing the strike price to the price occurring on the specific day when the option is exercised.

Average price call options are also known as Asian options and are considered a type of exotic option.

Understanding Average Price Calls

Average price call options are part of a broader category of derivative instruments known as average price options (APOs), which are sometimes also referred to as average rate options (AROs). They are mostly traded OTC, but some exchanges, such as the Intercontinental Exchange (ICE), also trade them as listed contracts. These kinds of exchange-listed APOs are cash-settled and can only be exercised on the expiration date, which is the last trading day of the month.

Some investors prefer average price calls to traditional call options because they reduce the option's volatility. Because volatility increases the likelihood that an option holder will be able to exercise the option during its term, this means that average price call options are generally less expensive than their traditional counterparts.

The opposite of an average price call is an average price put, in which the payoff is positive if the average price of the underlying asset is less than the strike price during the option's term.

Real World Example of an Average Price Call

To illustrate, suppose you believe that interest rates are set to decline and therefore wish to hedge your exposure to Treasury bills (T-bills). Specifically, you wish to hedge $1 million worth of interest rate exposure for a period of one month.

You begin considering your options and observe that T-bill futures are currently trading in the market at $145.09. To hedge your interest rate exposure, you purchase an average price call option whose underlying asset is T-bill futures, in which the notional value is $1 million, the strike price is $145.00, and the expiration date is one month in the future. You pay for the option with a $45,500 premium.

One month later, the option is about to expire and the average price of the T-bills futures over the previous month has been $146.00. Realizing that your option is in the money, you exercise your call option, buying for $145.00 and selling at the average price of $146.00. Because the average price call option had a notional value of $1 million, your profit is $954,500, calculated as follows:

Profit = (Average Price  Strike Price)× Notional Value  Option Premium PaidProfit = ($146.00  $145.00)× $1,000,000  $45,500\begin{aligned}&\text{Profit}\ = \ (\text{Average Price}\ - \ \text{Strike Price})\\&\qquad\qquad \times\ \text{Notional Value}\ - \ \text{Option Premium Paid}\\&\text{Profit}\ = \ (\$146.00\ - \ \$145.00)\\&\qquad\qquad \times\ \$1,000,000\ - \ \$45,500\\&\text{Profit}\ =\ \$954,500\end{aligned}Profit = (Average Price  Strike Price)× Notional Value  Option Premium PaidProfit = ($146.00  $145.00)× $1,000,000  $45,500

Alternatively, if the average price of T-bills over this period had been $144.20 instead of $146.00, then the option would have expired worthless. In that scenario, you would have experienced a loss equal to the option premium, or $45,500.