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Forward start option

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Forward start option

In finance, a forward start option is an option that starts at a specified future date with an expiration date set further in the future.[1] A forward start option starts at a specified date in the future; however, the premium is paid in advance, and the time of expiration is established at the time the forward start option is purchased.[2] Since the asset price at the start of this option is not known a priori, it is common to specify that the strike price will be set in the future so that the option is initially at the money or a certain percentage in the money or out of the money. This contract can be used to give an investor exposure to forward volatility. Executive stock options can be viewed as a type of forward start option. This is because a company commits to granting at-the-money options to employees in the future.[3]

A series of consecutive forward start options creates a cliquet option.[2]

Valuation

In a Black–Scholes model, the value of the forward-start option is proportional to the asset price. Therefore the value of the forward-start option is a multiple of the current asset price, with that multiple depending on forward volatility.

References

  1. ^ Musiela-Rutkowski: Martingale Methods in Financial Modelling, 2nd Edition, page 197
  2. ^ a b Riskglossary.com
  3. ^ Spirn, Daniel. (March 31, 2008). Options, Futures, Derivatives. School of Mathematics, University of Minnesota. Retrieved from http://www.math.umn.edu/~spirn/5076/Lecture16.pdf

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