What is Low Exercise Price Option ?
243 reads · Last updated: December 5, 2024
A low exercise price option (LEPO) is a European-style call option with an exercise price of one cent. Both buyer and seller operate on margin and, because it is almost a certainty that the holder will exercise the option at maturity, it is somewhat similar to a futures contract.
Definition
A Low Exercise Price Option (LEPO) is a type of European call option with an exercise price of just one cent. This means that the option holder is almost certain to exercise the option at expiration. Due to this certainty, both buyers and sellers use margin, making LEPO somewhat similar to a futures contract.
Origin
Low Exercise Price Options first appeared in financial markets as a tool to provide a more certain investment vehicle. They were designed to simplify options trading by making it more akin to futures contracts, thus attracting investors who prefer the near certainty of exercising the option at expiration.
Categories and Features
LEPOs are European options, meaning they can only be exercised on the expiration date. Their main feature is the extremely low exercise price (typically one cent), which makes them almost certain to be exercised at expiration. Due to this characteristic, LEPOs require both buyers and sellers to provide margin to ensure the fulfillment of contract obligations at expiration. Compared to traditional options, the risk and reward structure of LEPOs is more similar to that of futures contracts.
Case Studies
Case Study 1: Suppose an investor purchases a LEPO on a publicly listed company's stock. With an exercise price of just one cent, the investor is highly likely to exercise the option at expiration, thereby acquiring ownership of the underlying stock. Case Study 2: A financial institution uses LEPOs to hedge its stock portfolio risk. By holding LEPOs, the institution can lock in the purchase price of stocks during market fluctuations, thus reducing market risk.
Common Issues
Common issues investors face when using LEPOs include misunderstandings about margin requirements and confusion with traditional options. Due to the extremely low exercise price of LEPOs, investors need to understand their similarity to futures contracts and be prepared to provide the necessary margin.
