Discover the Power of Low Exercise Price Options (LEPOs)
A Low Exercise Price Option (LEPO) is a European-style call option that features an exercise price of just one cent. This peculiar characteristic makes it almost inevitable for the option to be exercised at maturity, thereby making it similar in function to a futures contract. Both the buyer and seller operate on margin in this trading scheme.
Key Takeaways
- LEPOs act as European-style call options with an exercise price of one cent, mimicking futures contracts.
- They function as deep-in-the-money options that emulate the behavior of the underlying stock.
- Traders buying or selling LEPOs engage in margin trading.
- LEPO options are not available for trading on U.S. exchanges.
A Deeper Dive into LEPOs
Originally launched in Switzerland, LEPOs quickly expanded to Finland as a method to circumvent stamp duties on stock trading. With a strike price near zero, investors gain many benefits associated with owning the underlying stock apart from dividends and voting rights.
In 1995, the Australian Stock Exchange (ASX) began offering these options, and as of now, lists them on nearly 100 ASX-listed companies.
LEPOs vs. Standard Options: What Sets Them Apart?
Standalone LEPOs have unique features when compared to regular or standard options:
- LEPOs are exclusively offered as call options.
- They follow the European-style expiration only.
- With the strike price deeply in the money, they trade similarly to the underlying stock itself.
- Purchases on margin allow buyers not to pay the full premium upfront.
- Ongoing margin payments are shared by both buyers and sellers.
- Holders do not earn dividends or secure voting rights until the option is exercised.
These options also serve as de facto forward or futures contracts. Standard options give the right, but not the obligation, to buy the underlying asset. Because LEPOs feature a minuscule strike price, they almost always expire in the money, making automatic exercise imminent, equating them to futures contracts with an obligation to take delivery. However, just like any option or future, they can be sold to close the position, thereby avoiding delivery of the underlying asset.
The Pros and Cons of LEPOs
Given their nature as deep in-the-money call options with high delta values, LEPOs compare closely to the underlying stock’s performance. Their European style restricts exercising until expiration, where the insignificant strike price makes eventual exercise almost inevitable. The primary benefit is market participation without the ownership complications of directly holding stocks.
These options generally carry high premiums. However, the advantage lies in owning them on margin, which reduces initial costs. Despite the numerous advantages, potential traders must consider the disadvantage of not receiving dividends or possessing voting rights.
Related Terms: Futures Contract, Forward Contract, Margin Trading, Deep In The Money Option, European-style Options.
References
- ASX. “LEPOs Low Exercise Price Options Explanatory Booklet”, Page 4.
- ASX. “Single Stock Option Registration Fee Schedule July 2021”.
