What is 'Traded Average Price Option (TAPO)'

A traded average price option (TAPO) is an option contract where the investor's profit or loss has a basis, not solely on the price of the underlying asset at expiration, but on the difference between the strike price and the average price.

First offered in 1987, by the Banker's Trust in Tokyo, TAPOs, are also known as Asian Options. The first options were for oil but the instrument now mainly trades in metals.

BREAKING DOWN 'Traded Average Price Option (TAPO)'

Traded Average Price Option (TAPO) is an over-the-counter (OTC) product. Their payoff has a basis on the average price of the underlying asset over a specified timeframe. The determination of the average price is at contract creation. For example, settlement values originate from the difference between the strike price and the average price of the underlying asset on the dates selected over the life of the options contract.

Compared to standard options contracts, TAPOs have a lower premium due to their frequently short lifespan. The premium is also less than exchange traded contracts due to the way these specific contracts derive their value. Rather than a contract having a daily price, you are receiving an average price throughout a specified amount of days. Asian Options have a higher risk, which reflects in their lower premiums.

Who Uses Traded Average Price Options

TAPOs enable traders to manage volatility risk and offer a cost-effective alternative to standard listed options. They are options contracts with a price that is determined by the price of the underlying asset during a period as opposed to a value determined at maturity. TAPOs cost less than regular options and protect investors from market volatility risk. Having an American execution, holders may exercise at any time during the life of the contract on the specified dates. Asian options are in the exotic options category, and their use gains favor with commodity suppliers.

Typical uses include:

  1. When a business is concerned about the average exchange rate over time
  2. When a single price at a point in time might be subject to manipulation
  3. When the market for the underlying asset is highly volatile
  4. When pricing becomes inefficient due to thinly traded, low liquidity, markets

Trading Exchanges for TAPOs

One exchange where TAPOs are commonly traded is the London Metal Exchange (LME), a significant marketplace for futures in non-ferrous metals such as aluminum, copper, lead, and zinc. These call and put options come in contract lengths ranging from one to 27 calendar months, and the monthly average settlement price determines their settlement price. TAPOs, traded options and futures are all used as hedging tools. While investors have to keep in mind the counterparty risk, these options are a low-cost strategy to protecting profits.

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