Forward start option

What is it?

  • An option that will start some time in the future, where the strike price is not fully determined until an intermediate date t before maturity T.

How is it constructed?

  •  It can be constructed as a call or a put, and can be either European or American.
  •  On the start date, the strike is typically the prevailing spot price (ATM), or is set to a proportion of the underlying asset price at the time of determination.
  • The premium is paid at time zero.

When is it used?

  • Enables investors to monetise growth in dividends without taking market risk.
  • They are the building blocks to cliquet options.

What are the benefits?

  • Cost is known although the option comes into existence only in the future.
  • Maximum loss is the premium paid.

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