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A forward start option
is an advance purchase of a put or
call option that will become active at some
specified future time. It is essentially a
forward on an option, only the premium is paid in advance.
The
underlier and time to
expiration are specified at that time. The
strike
price is determined when the option becomes active. Typically, it is set
at-the-money based upon the underlier value at that time. Alternatively,
it can be set a pre-determined percentage
in-the-money or
out-of-the-money.
A ratchet option (also
called a reset option or
cliquet option) is a series of
consecutive forward start options. The first is active immediately. The
second becomes active when the first expires, etc. Each option is struck
at-the-money when it becomes active. The effect of the entire instrument
is of an option that periodically "locks in" profits in a manner
somewhat analogues to a mechanical ratchet. Ratchet features can
be incorporated into other structures. For example, there are
ratchet caps or
ratchet floors.
Rubinstein (1991) provides
analytic formulas for pricing forward start options.
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copyright © Glyn A. Holton,
2002
Although the information in
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accurate. Such information may be incomplete, condensed, outdated or presented with
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investment advice. |
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