Pricing and Hedging Quanto Forward-Starting Floating-Strike Asian Options

Abstract

The rapid development and proliferation of derivatives around the world has produced numerous complicated contracts. Relatively few have attracted much interest in the marketplace, but some have become actively traded. If a derivatives contract is based on an underlying asset denominated in a different currency, a quanto adjustment is required to adjust for the correlation between the exchange rate and the price of the underlying asset. If a contract is intended to hedge against an adverse price change on something that has to be purchased regularly rather than at a single future date, such as natural gas for home heating, it makes sense for its payoff to be based on the average price over a period of time. And if that averaging period starts at a future date, not at contract initiation, one can arrive at a quanto forward-starting floating- strike Asian option. This article presents approximate closed form valuation models for four different types of these contracts and provides formulas for their Greek risk exposures.

TOPICS: Options, currency, analysis of individual factors/risk premia