Forward start option

Forward start option

A forward start option is an option that commences at some specified future date with an expiration further in the future. It is essentially a forward on an option, only the premium is paid in advance. [ [http://www.riskglossary.com/link/forward_start_option.htm Riskglossary.com] ] 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.

A series of consecutive forward start options creates a cliquet option. [ [http://www.riskglossary.com/link/forward_start_option.htm Riskglossary.com] ]

Valuation

In a Black-Scholes setting, the value of an at-the-money option is proportional to the asset price. The value of the forward-start option is therefore a multiple of the current asset price, with that multiple depending on forward volatility.

References


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