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Low Exercise Price Option

A Low Exercise Price Option (LEPO) is an Australian Stock Exchange traded option with a low exercise price that was specifically designed to be traded on margin. It is a European style call option with a low exercise price of $0.01 and a contract size of 100 shares to be delivered on exercise.

The premium is close to the whole share price, and a trader only posts margin, not the full price. Both the buyer and the seller are margined, all positions are marked-to-market daily. LEPOs work like a futures contract.

History edit

The Australian Stock Exchange started listing LEPO exchange traded options in 1995 to allow traders to trade underlying shares on margin. In 2018, there are 100 ASX listed companies that offer LEPO contracts. [1]

Differences from standard options edit

Several important differences distinguish LEPOs from standard exchange-traded options, and these differences have important implications for the pricing of LEPO.

  • The buyer of a LEPO does not pay the full amount of the premium upfront.
  • Both buyer and seller of LEPOs involve ongoing margin payments.
  • The buyer of a LEPO does not receive dividends or obtain voting rights on the underlying shares until the shares are transferred after exercise.
  • LEPOs are only available as call options.
  • LEPOs have a very low exercise price and a high premium close to the initial value of the underlying shares.
  • LEPOs have only one exercise price per expiry month.

LEPOs may be over either shares or an index.

Pricing of Low Exercise Price Options edit

The current value of a contract is equal to the current price of the underlying share compounded by the risk-free interest rate, less the accumulated value of any dividends, less the exercise price of $0.01.

 

where:

  •   = price of LEPO contract entered into at time 0 for delivery at time 1;
  •   = price of underlying share at time 0;
  • r = risk-free rate of return;
  • n = number of days until contract maturity;
  • D = value of share dividends;
  • y = number of days until dividend is paid.
  • X = exercise price (equals $0.01);

To prove that above formula is correct, we'll calculate price using Black–Scholes formula. The Black–Scholes formula after modifications to recognize that the premium is paid at the expiry of the contract:

 

where:

N(d) is cumulative probability distribution function for a standard normal distribution.

 
 

For a LEPO an underlying price   is very big compare to exercise price X. Because of that   is very close to 1, with insignificant difference. Thus LEPO price per Black–Scholes formula (without dividend) is

 

and it matches our previous formula.

References edit

  1. Stephen A. Easton, Sean M. Pinder “The Pricing of Low Exercise Price Options”
  2. Low Exercise Price Options Explanatory Booklet, ASX

exercise, price, option, lepo, australian, stock, exchange, traded, option, with, exercise, price, that, specifically, designed, traded, margin, european, style, call, option, with, exercise, price, contract, size, shares, delivered, exercise, premium, close, . A Low Exercise Price Option LEPO is an Australian Stock Exchange traded option with a low exercise price that was specifically designed to be traded on margin It is a European style call option with a low exercise price of 0 01 and a contract size of 100 shares to be delivered on exercise The premium is close to the whole share price and a trader only posts margin not the full price Both the buyer and the seller are margined all positions are marked to market daily LEPOs work like a futures contract Contents 1 History 2 Differences from standard options 3 Pricing of Low Exercise Price Options 4 ReferencesHistory editThe Australian Stock Exchange started listing LEPO exchange traded options in 1995 to allow traders to trade underlying shares on margin In 2018 there are 100 ASX listed companies that offer LEPO contracts 1 Differences from standard options editSeveral important differences distinguish LEPOs from standard exchange traded options and these differences have important implications for the pricing of LEPO The buyer of a LEPO does not pay the full amount of the premium upfront Both buyer and seller of LEPOs involve ongoing margin payments The buyer of a LEPO does not receive dividends or obtain voting rights on the underlying shares until the shares are transferred after exercise LEPOs are only available as call options LEPOs have a very low exercise price and a high premium close to the initial value of the underlying shares LEPOs have only one exercise price per expiry month LEPOs may be over either shares or an index Pricing of Low Exercise Price Options editThe current value of a contract is equal to the current price of the underlying share compounded by the risk free interest rate less the accumulated value of any dividends less the exercise price of 0 01 L0 1 S0er n 365 Der n y 365 X displaystyle L 0 1 S 0 e r n 365 De r n y 365 X nbsp where L0 1 displaystyle L 0 1 nbsp price of LEPO contract entered into at time 0 for delivery at time 1 S0 displaystyle S 0 nbsp price of underlying share at time 0 r risk free rate of return n number of days until contract maturity D value of share dividends y number of days until dividend is paid X exercise price equals 0 01 To prove that above formula is correct we ll calculate price using Black Scholes formula The Black Scholes formula after modifications to recognize that the premium is paid at the expiry of the contract L0 1 S0N d1 Xe rn 365N d2 ern 365 displaystyle L 0 1 S 0 N d 1 Xe rn 365 N d 2 e rn 365 nbsp where N d is cumulative probability distribution function for a standard normal distribution d1 ln S0 X r s2 2 n 365 sn 365 displaystyle d 1 dfrac ln S 0 X r sigma 2 2 n 365 sigma sqrt n 365 nbsp d2 d1 sn 365 displaystyle d 2 d 1 sigma sqrt n 365 nbsp For a LEPO an underlying price S0 displaystyle S 0 nbsp is very big compare to exercise price X Because of that N d1 displaystyle N d 1 nbsp is very close to 1 with insignificant difference Thus LEPO price per Black Scholes formula without dividend is L0 1 S0ern 365 X displaystyle L 0 1 S 0 e rn 365 X nbsp and it matches our previous formula References editStephen A Easton Sean M Pinder The Pricing of Low Exercise Price Options https web archive org web 20110303213813 http www agsm edu au eajm 9812 pdf easton pdf Low Exercise Price Options Explanatory Booklet ASX https web archive org web 20100917192520 http asx com au products pdf UnderstandingLEPOs pdf Retrieved from https en wikipedia org w index php title Low Exercise Price Option amp oldid 1056477176, wikipedia, wiki, book, books, library,

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