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What Is an XPO (Perpetual Option) in Investing?

Sebencapital

Published
22/12/23
What Is an XPO (Perpetual Option) in Investing?

DEFINITION:

XPOs, known as perpetual or non-standard options, have no expiration dates and remain valid indefinitely. They are also sometimes referred to as exotic or expirationless options.

Definition and Examples of an XPO (Perpetual Option)

An XPO, unlike a regular option, doesn't come with an expiration date. Regular options have a specific expiration date and usually allow the owner to buy or sell 100 shares of the underlying asset at a set price.

  • Alternate name: An expirationless option is an option that doesn't have an expiration date. It's also known as a non-standard or exotic option.

Note

An expirationless option, often called an XPO, doesn't come with an expiration date. It falls under the category of non-standard or exotic options. These kinds of options aren't frequently traded like standard options on major stock exchanges; instead, they are traded over-the-counter (OTC).

When you buy a perpetual option, you can choose to exercise it whenever it suits you in the future.

How Does an XPO Work?

Standard options lose value over time due to time decay as they approach their expiration dates. To avoid this risk, some investors prefer perpetual option contracts, also known as XPOs, because they don't have expiration dates.

For instance, imagine an investor buys an XPO on crude oil at its current price of ₹70, setting a strike price of ₹90 without an expiration date. The XPO becomes profitable once the oil price goes beyond ₹90. However, to cover the premium paid for the option (let's say ₹30), the oil price needs to reach ₹100 for the investor to break even.

Note

"Being in the money" doesn’t always mean making a profit. To make a profit, investors need to consider the price they paid for the option contract when calculating the break-even point.

Sure, here's a simplified and SEO-friendly version:

With a non-expiring option (XPO), the person who owns the contract can hold onto it indefinitely. The seller, or writer, of the contract must fulfill their side of the deal as long as the contract remains valid, until the owner decides to use it.

Since XPOs have no expiration date, sellers can charge a much higher price (premium) compared to standard options that have expiration dates.

The price of standard options is calculated using the Black-Scholes Model, which depends on six factors. These factors include the current price of the thing the option is for, the strike price (the agreed buying or selling price), time left until expiration, interest rates, volatility of the thing being traded, and dividends. These factors together determine the price of a standard option.

  • The cost of the actual stock or asset being traded.
  • The anticipated regular payments made by a company to its shareholders who own the stock.
  • The measure of how much the price of a stock or asset tends to change over time.
  • The present expected interest rate on an investment without any risk involved.
  • The agreed-upon price at which an option allows you to buy or sell an asset.
  • The duration or length of time that an option contract remains valid or active.

An XPO, which doesn't have an expiry date, presents a challenge in pricing. Various methods, including modified versions of the Black-Scholes model, have been employed to determine the value of an XPO. These adaptations consider the characteristics of the Black-Scholes model but adjust for the absence of a specific expiration period in XPOs.

Pros and Cons of an XPO

Pros

  • No expiration risk
  • Buy/sell flexibility
  • Lower trading costs

Cons

  • Deciding when to exercise
  • Liquidity risk

Pros Explained

  • No expiration: risk means that an XPO (non-expiring option) doesn't have a specific end date. This eliminates the worry that your option will lose its value because it expired without being used.
  • Investors enjoy greater flexibility in deciding when to buy or sell their XPO contracts because these contracts don't come with an expiration date.
  • Because XPOs don't expire, there are no costs linked to rolling over options, resulting in lower trading expenses.

Cons Explained

  • Determining when to use an XPO can be trickier because there's no set expiration date. You need to consider if the return on investment, considering the time you've held the contract, justifies exercising it when it's profitable. It might also prompt you to think if investing in a different security would offer a better return.
  • Selling a perpetual option contract might be difficult because it's not a common type of contract. This means there are fewer potential buyers in the market, making it harder to sell your contract quickly if you want to.

What It Means for Individual Investors

Many investors avoid trading XPOs because of their limited market and unique characteristics. Perpetual options are less common and not easily accessible due to these features.

However, while non-expiration is an advantage, holding onto an XPO for too long could also be risky. If the value of the underlying security doesn’t move favorably, it might not lead to profits. It's advisable to consult a financial expert before investing in XPOs to ensure you make informed decisions.

Key Takeaways

  • XPOs are option contracts without set expiration dates.
  • XPOs are known by various names like perpetual options, non-standard options, exotic options, and expirationless options.
  • XPOs might have higher premiums because they don't have specific expiration dates.
  • XPOs offer flexibility to investors due to their lack of expiration dates. This flexibility also helps decrease the trading expenses related to rolling over options.

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Written by Sauravsingh

Techpreneur and adept trader, Sauravsingh Tomar seamlessly blends the worlds of technology and finance. With rich experience in Forex and Stock markets, he's not only a trading maven but also a pioneer in innovative digital solutions. Beyond charts and code, Sauravsingh is a passionate mentor, guiding many towards financial and technological success. In his downtime, he's often found exploring new places or immersed in a compelling read.

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