A forward start option is an option that commences at some specified future date with an expiration further in the future. It is essentially a forward on an option, only the premium is paid in advance.[1] Since the asset price at the start of this option is not known a priori, it is common to specify that the strike price will be set in the future so that the option is initially at the money or a certain percentage in the money or out of the money. This contract can be used to give an investor exposure to forward volatility.
A series of consecutive forward start options creates a cliquet option.[1]
Valuation
In a Black-Scholes setting, the value of an at-the-money option is proportional to the asset price. The value of the forward-start option is therefore a multiple of the current asset price, with that multiple depending on forward volatility.
References
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