Alternate name: expirationless option, non-standard option, exotic option
By purchasing a perpetual option contract, you have the luxury of exercising the contract at any point in the future when it makes sense for you to do so.
How Does an XPO Work?
Standard options contracts are affected by time decay, which means that their values diminish as the contracts approach their expiration dates. Rather than worrying about time degrading the value of an option contract, an investor may decide to purchase a perpetual option contract if they want to remove the expiration risk of a standard option. For example, an investor decides to buy an option contract on crude oil, currently trading at $70. The investor selects a strike price of $90, with no expiration date to exercise the option, making this an XPO. The option will be considered “in the money” once it surpasses a price of $90. However, in order for the investor to be profitable, they need to make up for the premium they paid for the option contract. Let’s assume they paid a premium of $30 for the contract. That would mean the investor would not break even until the price of crude oil reached at least $100. Theoretically, the owner of the option contract could hold on to that XPO in perpetuity, and the writer of that contract is obligated to fulfill their end of the bargain as long as that option contract is valid (which would be until the owner exercises the contract). However, the XPO is a non-expiring option contract, so the writer of the option contract may charge a much heftier premium than a standard option. Standard options are priced using the Black-Scholes Model, in which the price of the option is dependent on six factors:
Price of the underlying stock Expected dividends of underlying stock Underlying stock volatility The current estimated risk-free interest rate The exercise price of the option The option contract’s term
Notice that the last bullet point is the option contract term. Since an XPO doesn’t have an expiration date, it’s more challenging to price. There have been many ways used to price an XPO option contract, with many using the Black Scholes-based model with the exception of not having a defined term.
Pros and Cons of an XPO
Pros Explained
No expiration risk: An XPO contract comes with the benefit of not having an expiration date. This removes the risk of your option expiring worthless. Buy/sell flexibility: Investors have much more flexibility in choosing when to buy or sell their XPO contract since there is no expiration date. Lower trading costs: Due to the non-expiring benefit of an XPO, trading costs associated with rolling over options are nonexistent.
Cons Explained
Deciding when to exercise: Since an XPO contract has no expiration date, deciding when to exercise becomes more complicated when taking into consideration the time value of money. If you’re in the money past your break-even point, will you have made a satisfying return on investment given the time you’ve owned the contract? Or would it have been better to invest in another security for a better return? Liquidity risk: Due to the non-standard nature of a perpetual option contract, there is a very small market of investors to sell to should you want to sell your contract on the secondary markets. Because of this, you may not be able to sell the contract to the secondary market as soon as you would like.
What It Means for Individual Investors
Most investors will not deal with trading XPOs due to the small market and unique components. Those features also make perpetual options relatively less common and accessible for investors. Keep in mind that the non-expiring benefit can also be a risk if you hold on too long and your underlying security never moves in a profitable pricing direction. Talk to a financial professional to ensure you are covering all your bases before investing in an XPO. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
