Commodity Average Price Option

ORE defines the product as follows:

The (Arithmetic) Average Price Option (APO) is an Asian option with a single-period Commodity Swap as an underlying which observes daily price fixings in the calculation period.

Source: ORE User Guide, Products catalogue, commodityapo.tex.

A commodity APO is a bet on an average. The daily commodity prices over a period decide the payoff. One side pays a fixed price. The other side pays what the average turns out to be. The average smooths the swings of a single day.

The CommodityAveragePriceOptionData node carries OptionData, an optional BarrierData, the commodity Name, the StrikeData, the Quantity, and the period dates. Exercise happens at the calculation period end, typically on the last floating price fixing date. This contrasts with the Commodity Swaption, whose expiry comes before the underlying swap starts. In a call option, the owner has the right to receive average floating prices and to pay fixed prices. In a put option it is the other way around. APOs can occur in combinations, such as series of puts and calls at different strikes, and over a series of consecutive calculation periods.

The floating average is the arithmetic mean of the daily fixings over the period. The call payoff is the difference between that average and the strike, when positive. The average reduces the volatility of the payoff relative to a single-fixing option. The value prices off the commodity forward curve at each observation date and the volatility of the average.

• The commodity forward curve at each observation date. It drives the expected average.
• The volatility of the daily fixings. It sets the value of the average optionality.
• The strike and the quantity.
• The barrier level and style, when present.
• The discount curve of the settlement currency.

A call gains when the average rises above the strike. A put gains when the average falls below it.

Each daily fixing turns part of the average from unknown to known. The remaining fixings keep their market exposure. The averaging window closes as the period end approaches. At the last fixing date the average is known and the option settles. After settlement the trade stops.

A consumer who buys commodities month by month wants protection on the period average, not on one date. An airline, a refiner, or a utility has exactly this exposure. The average makes the hedge cheaper than a series of single-date options. In ORE Studio a customer books commodity APOs to value them and run sensitivities on the ORE engine.

ORE's catalogue shows a short call with an up-and-in barrier:

<Trade id="...">
  <TradeType>CommodityAveragePriceOption</TradeType>
  <Envelope>
    ...
  </Envelope>
  <CommodityAveragePriceOptionData>
    <OptionData>
      <LongShort>Short</LongShort>
      <OptionType>Call</OptionType>
      <Style>European</Style>
      <ExerciseDates>
        <ExerciseDate>2020-01-31</ExerciseDate>
      </ExerciseDates>
    </OptionData>
    <BarrierData>
      <Type>UpAndIn</Type>
      <Style>American</Style>
      <LevelData>
        <Level>
          <Value>80</Value>
        </Level>
      </LevelData>
    </BarrierData>
    <Name>NYMEX:CL</Name>
    <Currency>USD</Currency>
    <Quantity>6000</Quantity>
    <StrikeData>
      <StrikePrice>
        <Value>80</Value>
        <Currency>USD</Currency>
      </StrikePrice>
    </StrikeData>
    <PriceType>FutureSettlement</PriceType>
    <StartDate>2022-01-01</StartDate>
    <EndDate>2023-01-31</EndDate>
  </CommodityAveragePriceOptionData>
</Trade>

Source: ORE User Guide, Products catalogue, commodityapo.tex, listing Commodity Average Price Option (optional elements omitted).