Binary Option, Look Back Option, Asian Option

Binary Option

A binary option is a derivative financial product with a fixed (or maximum) payout if the option expires in the money, or the trader losses the amount they invested in the option if the option expires out of the money. The success of a binary option is thus based on a yes or no proposition, hence “binary”. Binary options have an expiry date and/or time. At the time of expiry, the price of the underlying asset must be on the correct side of the strike price (based on the trade taken) in order for the trader to make a profit.

A binary option automatically exercises, meaning the gain or loss on the trade is automatically credited or debited to the trader’s account when the option expires.

Look Back Option

Lookback options are exotic contracts that offer the holder the advantage of being able to exercise at an optimal point. Essentially, at expiration the holder can look back (hence the name) at how the price of the underlying asset has performed and maximize their  profits by taking advantage of the biggest price differential between the strike price and the price of the underlying asset.

For options traders this is obviously a major benefit, as lookback options can be used to solve one of the biggest problems they face: market timing. This is basically choosing when to enter a position and when to exit it, with the aim obviously being to time entry and exit to make the largest possible returns.

Because of the way lookback options work, the issue of market timing becomes less important as profits are effectively guaranteed to be maximized. Also, the chances of a contract of this type expiring worthless are much lower than other types of options. For these reasons lookbacks are generally more expensive, so the advantages do come at a cost.

Lookbacks can be either calls or puts, so it’s possible to speculate on either the price of the underlying security going up in value or going down. They are also known as hindsight options, as they actually give the holder the benefit of hindsight when determining when to exercise.

To fully understand how they work, you need to be aware of the two different types of lookback options – fixed strike and floating strike. Although the concept of these two types is very similar, and both offer the potential for maximizing returns.  There is a fundamental difference between the two and the way they work. On this page we have explained both types in more detail.

Asian Option

An Asian option (or average value option) is a special type of option contract. For Asian options the payoff is determined by the average underlying price over some pre-set period of time. This is different from the case of the usual European option and American option, where the payoff of the option contract depends on the price of the underlying instrument at exercise; Asian options are thus one of the basic forms of exotic options. There are two types of Asian Fixed Strike option, the Asian Fixed Strike call and the Asian Fixed Strike put. In general they do not differ in definition, only in how the pay-off is calculated.

One advantage of Asian options is that these reduce the risk of market manipulation of the underlying instrument at maturity (Kemna & 1990 1077). Another advantage of Asian options involves the relative cost of Asian options compared to European or American options. Because of the averaging feature, Asian options reduce the volatility inherent in the option; therefore, Asian options are typically cheaper than European or American options. This can be an advantage for corporations that are subject to the Financial Accounting Standards Board (2004 & FASB) revised Statement No. 123, which required that corporations expense employee stock options.