Options & Derivatives Trading

Low Strike Option (LEPO)

What is a Low Strike Option (LEPO)?

A Low Strike Option (LEPO) is a European-style call option with a strike price of 1 cent. Both buyers and sellers operate on margin, which is somewhat similar to a futures contract in that it is almost certain that the holder will exercise the option at expiration.

key takeaways

  • A Low Strike Option (LEPO) is a European-style call option with a strike price of 1 cent that mimics a futures contract.
  • LEPOs function like deep options on the stock itself.
  • Both buyers and sellers of LEPO operate on margin.
  • LEPO options are not available on any US exchange.

Understanding Low Strike Option (LEPO)

LEPO originated in Switzerland and spread quickly to Finland to avoid paying the stamp duty required for stock transactions. With the strike price so close to zero, investors who buy LEPO get most of the features of owning the stock outright, with the exception of dividends and voting rights.

The Australian Securities Exchange (ASX) began listing LEPO options in 1995, and as of July 2021, offers these options to nearly 100 ASX-listed companies.

LEPO and general options

LEPO differs from regular or standard options in several key ways.

  • LEPO is only offered as a call option.
  • They only apply to European expirations.
  • They are so deep in the currency (ITM) that they trade in a similar way to the underlying stock itself.
  • Buyers buy them on a security deposit, so they don’t have to pay the full premium up front.
  • Both buyers and sellers will continue to pay margin.
  • Holders do not receive dividends or have voting rights until exercised.

Conceptually, LEPOs also act as forward contracts or futures. Standard options give the holder the right but no obligation to purchase the underlying security at or before expiration. However, because the strike price is so low, the probability that the option will expire at the ITM and thus be automatically exercised on the expiration date is almost certain. Essentially, a LEPO is a futures contract with an obligation to take delivery.

Of course, all options and futures may be sold to close the position and avoid taking delivery of the underlying.

Advantages and Disadvantages of Low Strike Option (LEPO)

Since LEPOs are essentially deep ITM call options, they have very high delta values ​​and trade similarly to the underlying stock. Because these options are European-style options that can only be exercised at expiration, their near-zero strike price almost guarantees that the holder will receive the stock at that time. The advantage over holding stocks directly is participating in the performance of the underlying asset without any financial or legal issues arising from holding stocks directly.

Deep ITM options have a very high premium or initial cost. However, investors hold LEPO on margin, which reduces upfront costs. Again, the benefits must be weighed against the downside of not having the right to claim dividends or vote on the stock.

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