What is a forward-start option and where is it used?

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AcadiFi · Accepted Answer

A forward-start option is an option whose strike is set at a future date rather than at inception, typically to be at-the-money on that future date. Purchase and premium occur today, but the strike only crystallizes when the forward-start date arrives, usually as a percentage (often 100 percent) of the spot at that date. Example: HR analyst Beatriz Huaman at Altiplano Telecom designs a three-year employee option plan where grants start in one year. The strike on each grant equals the stock price one year from now. Employees get a standard two-year at-the-money option from years one to three, but the grant is locked in today for planning purposes. Pricing leverages a clean result: under Black-Scholes and constant volatility, the value of a forward-start option today equals the present value of a vanilla option evaluated at the forward date. Because the option will be struck at-the-money on day one (the forward-start date), its future value is proportional to the underlying price on that day. This scaling yields a closed-form solution essentially identical to Black-Scholes with the strike set to spot and the time-to-maturity measured from the forward-start date. ```mermaid flowchart LR T0[Today
Premium paid] --> T1[Forward-start
Strike locked] T1 --> T2[Expiry
Payoff] ``` Forward-starts are building blocks of cliquet options and are widely used in executive compensation and structured notes with reset features.

What is a forward-start option and where is it used?

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