Traded Average Price Option (TAPO) Definition
What is a Traded Average Price Option (TAPO)?
A Traded Average Price Option (TAPO) is an option contract in which the investor’s profit or loss is based on the difference between the strike price and the average price, not just the strike price. underlying asset at expiration.
First offered in 1987 by Banker’s Trust in Tokyo, TAPOs are also known as Asian Options. While the first TAPOs were for oil, the instrument now primarily trades metals.
Key points to remember
- In a Traded Average Price Option (TAPO), the profit or loss is the difference between the strike price and the average price of the asset during the term.
- Compared to standard options contracts, TAPOs have a lower premium due to their often short lifespan. The premium is also lower than that of exchange-traded contracts due to the way these specific contracts derive their value.
- TAPOs allow traders to manage volatility risk and offer a profitable alternative to standard listed options.
How a Traded Average Price (TAPO) Option Works
A traded mid-price option is a over the counter (OTC) product. Its gain is based on the average price of the underlying asset over a given period. The average price is determined when the contract is created. For example, settlement values come from the difference between the strike price and the average price of the underlying asset at selected dates over the life of the options contract.
Compared to standard option contracts, TAPOs have a lower premium due to their often short lifespan. The premium is also lower than that of exchange-traded contracts due to the way these specific contracts derive their value. Rather than a contract having a daily price, you receive an average price over a specified number of days. Asian options have higher risk, which is reflected in their lower premiums.
Who Uses Traded Average Price Options?
TAPOs allow merchants to manage volatility risk and offer a profitable alternative to the standard options listed. These are option contracts whose price is determined by the price of the underlying asset over a period of time as opposed to a fixed value at expiration. TAPOs cost less than regular options and protect investors against the risk of market volatility. Having a US execution, holders can exercise at any time during the term of the contract on the dates specified. Asian options fall into the category of exotic optionsand their use is gaining favor with raw material suppliers.
Common uses of Asian options include:
- A company that worries about the average exchange rate over a long period
- When a price at a given time may be subject to manipulation
- In the event that the market for an underlying asset becomes highly volatile
- If pricing becomes inefficient due to thinly traded and low liquidity markets
Commercial exchanges for TAPOs
One exchange where TAPOs are commonly traded is the London Metals Exchange (LME), a notable market for futures on non-ferrous metals such as aluminum, copper, lead and zinc. These call and put options have contract terms ranging from one to 27 calendar months, and the monthly average settlement price determines their settlement price. TAPOs, traded options and futures contracts are all used as hedging tools.