What Is a Low Exercise Price Option (LEPO)?
Let me explain what a low exercise price option, or LEPO, really is. It's a European-style call option with an exercise price set at just one cent. You, as the buyer or seller, operate on margin, and since it's almost guaranteed that the holder will exercise it at maturity, it acts a lot like a futures contract.
Key Takeaways
Here's what you need to grasp about LEPOs: they are European-style call options with a one-cent exercise price that essentially mimic futures contracts. They function as deep-in-the-money options, behaving much like the stock itself. Remember, both the buyer and seller work on margin, and these options aren't available on any U.S. exchanges.
Understanding a Low Exercise Price Option (LEPO)
LEPOs started in Switzerland and soon moved to Finland as a way to dodge the stamp duties on stock trading. When you buy a LEPO, you get most of the benefits of owning the share outright, but without dividends or voting rights, thanks to that strike price being so close to zero.
The Australian Stock Exchange, or ASX, started listing LEPO options back in 1995, and as of July 2021, they offer them on nearly 100 companies listed there.
LEPOs vs. Regular Options
LEPOs stand apart from regular options in several direct ways. They're only available as call options and come solely with European-style expirations, meaning you can only exercise them at maturity. These are so deep in the money that they trade just like the underlying stock. You buy them on margin, so you don't pay the full premium upfront, and both you as the buyer and the seller face ongoing margin payments. Plus, as the holder, you won't get dividends or voting rights until after you exercise.
The Conceptual Side: LEPOs as Forward Contracts
Conceptually, LEPOs work like forward contracts or futures. Regular options give you the right, but not the obligation, to buy the underlying security at or before expiration. But with a LEPO's super-low strike price, it's nearly certain to expire in the money and auto-exercise at expiration. In essence, it's a futures contract where you have to take delivery. Of course, you can always sell any option or future to close your position and avoid delivery.
Advantages and Disadvantages of Low Exercise Price Options (LEPOs)
Since LEPOs are basically deep in-the-money call options, they carry a very high delta and trade much like the underlying stock. Being European style, you can only exercise them at expiration, and with that near-zero strike, it's almost guaranteed you'll take delivery of the shares then. The big advantage over owning the stock directly is that you participate in its performance without the financial or legal hassles of actual ownership.
Deep in-the-money options come with high premiums, but with LEPOs, you hold them on margin, which means a lower upfront cost. That said, you have to weigh this against the downsides: no claim to dividends and no voting rights on the shares.
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