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Forward Start Options, explained and pricing formula

  
  
  
Resolution

A forward start options is an option where the exercise price isn't set till a date in the future.

They are sometimes used for employee stock options (ESO) where an employee is given a series of options with different maturity dates, but the strikes are all set in the future.

Once the strike is set on a forward start option they can be priced as a normal option. Details on pricing prior to the strike being set are below.

forward start option

Forward start options can be priced using the Rubinstein (1990) formula:

 

where

 ,

and where

c = Price of European call

p = Price of European put

S = The spot of the underlying asset

b = The cost of carry

r = The risk free rate

T = Time to expiry of the option

t = Elapsed time

N = The cumulative normal distribution function

= a positive constant, where the strike = S

= Volatility of underlying asset's price

 

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