What is the low strike price option?
A Low Strike Price Option (LEPO) is a European style call option with a strike price of one cent. The buyer and seller operate on margin. Since it is almost certain that the holder will exercise the option at maturity, it is somewhat similar to a futures contract.
Key points to remember
- LEPOs work similarly to futures.
- These work as deep options in the currency similar to the stock itself.
- The use of LEPO options requires continuous margin payments.
- LEPO options are not available on US exchanges.
Understanding the Low Strike Price Option (LEPO)
Low exercise price options (LEPO) originated in Switzerland and quickly spread to Finland to avoid paying the stamp duty charged when trading the shares. Since the strike price is so close to zero, the investor buying LEPO acquires most of the features of direct ownership of the stock, with the exception of dividends and voting rights.
The Australian Stock Exchange (ASX) listed LEPO options in 1995 and offers them from 2020 on 100 ASX listed companies.
Differences from regular options
Low strike price options differ from regular or standard options in several key ways.
- LEPOs are only available as calling options.
- Only available with European style expirations.
- They are so deep in currency that they trade similarly to the underlying stock itself.
- Buyers buy them on margin so as not to pay the full amount of the premium in advance.
- Buyers and sellers will have continuous margin payments.
- Holders do not receive dividends or voting rights before the exercise.
Conceptually, they also act as futures or futures. Standard options give the bearer the right, but not the obligation, to buy the underlying security at the latest on expiration. However, since the strike price is so low, the chances of the option expiring in the money and therefore exercising automatically on the expiration date are almost certain. Essentially, a low strike price option is a forward contract with an obligation to take delivery.
Of course, all options and futures can be sold to close out the position and avoid taking delivery of the underlying.
Use of LEPO
Since LEPOs are essentially a deep call option, they have a very high delta value and trade similarly to the underlying stock. Because these options are European style, which means they can only be exercised at maturity, their near zero exercise price almost guarantees that the holder will take delivery of the shares at that time. The advantage over outright share ownership is participation in the performance of the underlying without any financial or legal problems caused by the direct holding of the share.
Deep in monetary options have very high premiums, or upfront costs. However, the investor holds LEPOs on margin, which leads to lower initial costs. Again, the advantages must be weighed against the disadvantages of having no dividend rights or being able to vote on the shares.