Low Exercise Price Option
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 European call option with an exercise price of one cent. Due to the extremely low exercise price, it is almost certain that the holder will exercise the option at expiration, requiring both the buyer and the seller to use margin. This makes LEPO somewhat similar to a futures contract.
Origin: Low Exercise Price Options first appeared in the 1990s, primarily to provide a more liquid and transparent investment tool. They were initially introduced on the Australian Securities Exchange (ASX) to offer investors a simpler way to trade options.
Categories and Characteristics: LEPOs have the following key characteristics:
- Extremely low exercise price: Typically one cent, making it almost certain that the option will be exercised.
- Margin requirements: Due to the certainty of exercise, both the buyer and the seller need to provide margin.
- European option: Can only be exercised at expiration, unlike American options which can be exercised at any time before expiration.
Specific Cases:
- Case 1: Suppose an investor buys a LEPO with the underlying asset being a company's stock, and the exercise price is one cent. At expiration, if the company's stock price is $50, the investor will buy the stock at one cent, realizing a profit of $49.99 (excluding transaction fees and margin costs).
- Case 2: Another investor sells a LEPO with the underlying asset being an index fund, with the same exercise price of one cent. At expiration, if the index fund price is $100, the seller will need to sell the fund to the buyer at one cent, realizing a loss of $99.99 (excluding transaction fees and margin costs).
Common Questions:
- Q: Why do LEPOs require margin?
A: Due to the extremely low exercise price, it is almost certain that the option will be exercised, requiring both the buyer and the seller to provide margin to ensure the fulfillment of the trade. - Q: How do LEPOs differ from regular options?
A: LEPOs have an extremely low exercise price, making it almost certain that they will be exercised, whereas regular options typically have higher exercise prices with uncertain exercise probabilities.
