Low Exercise Price Option (LEPO): Meaning, Pros And Cons

What Is a Low Exercise Price Option (LEPO)?

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 certain that the holder will exercise the option at maturity, it is similar to a futures contract.

Key Takeaways

• A low exercise price option (LEPO) is a European-style call option with an exercise price of one cent that mimics a futures contract.
• LEPOs function as deep-in-the-money options similar to the stock itself.
• Both buyer and seller of a LEPO operate on margin.
• LEPO options are not available on any U.S. exchanges.

Understanding a Low Exercise Price Option (LEPO)

LEPOs originated in Switzerland and quickly spread to Finland to avoid paying required stamp duties charged on stock trading. Since the strike price is close to zero, the investor purchasing the LEPO gains most features of owning the share directly with the exceptions of dividends and voting rights.

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

LEPOs vs. Regular Options

LEPOs differ from regular options in several key ways.

• LEPOs are only available as call options.
• They are only available with European style expirations.
• They are deep in the money (ITM) and trade similarly to the underlying stock.
• Buyers purchase them on margin, so they do not pay the full premium amount upfront.
• Both buyers and sellers will have ongoing margin payments.
• Holders do not receive dividends or have voting rights until after exercise.

Conceptually, LEPOs also act as forward contracts or futures. Standard options give the holder the right but not the obligation to purchase the underlying security at or before expiration. However, since the strike price is low, the odds of the option expiring ITM and automatically exercising at expiration are almost certain. Essentially, a LEPO is a futures contract with the obligation to take delivery.

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

Advantages and Disadvantages of Low Exercise Price Options (LEPOs)

LEPOs, being deep ITM call options, have a high delta value and trade similarly to the underlying stock. Because these options are of the European style and can only be exercised at expiration, their near-zero strike price guarantees that the holder will take delivery of shares at that time. The advantage over owning the stock outright is the participation in the underlying’s performance without the financial or legal issues caused by direct holding of the stock.

Deep ITM options have high premiums or initial costs. However, the investor holds LEPOs on margin, resulting in a lower upfront cost. Again, the benefits must be weighed against the disadvantages of having no claim on dividends or the ability to vote the shares.