You wrote "To me, the concept of an expirationless option is somewhat nonsensical; what currently unmet need does it address?"
I have followed new derivative product development for some time, so I gave this question some consideration again last night. My conclusion continues to be that expirationless options (XPOs) are truly a revolutionary new product and the number of new or improved applications is enormous. It seems obvious at least to me that XPOs answer all kinds of unmet needs.
Some of the obvious examples:
(1) You could buy or sell a stock, currency or other non- expiring asset at a price other than the market price. Ex. MSFT is selling for $30, the XPO strike prices would allow an investor to buy or sell above and below $30.
(2) XPO puts allow you to create stock or portfolio protection for a fixed cost without risk of a margin call - better than shorting a stock and you don't have to worry about how hard the stock is to borrow, plus you would have the same multiple prices to select as (1) above. People could create "insurance" on their 401ks, pensions plans, etc. The market applications in this area alone are staggering.
Some might suggest that LEAPs do the same thing.... except that LEAPs expire. I reviewed that data in the LEAPS vs. XPOs paper and the results were very impressive... XPOs were a superior product in each comparison (see: nextrade.com
(3) XPOs should be treated like regular expiring options for tax purposes (since they are options should fall under the Open Transaction Doctrine) so some excellent tax-deferred income strategies can be developed by using the product in covered call strategies, collars etc. Publicly traded corporations will be able to use treasury stock more effectively by writing XPOs compared to just selling treasury stock.
(4) In the case of concentrated ownership in a single stock, an XPO call would allow diversification on a tax-deferred basis until the position was closed, without giving up dividends or voting rights. A great example of a this besides Bill Gates et al. would be a pension fund like McDonalds that has about 80% of its assets in McDonald's stock. This would be a HUGE opportunity for the pension fund to generate cash without selling equity and the cash would be tax-deferred. I expect that EVERY pension fund, bank, insurance company and hedge fund would use XPOs in this capacity once they are available.
(5) Obviously when compared to expiring options, the XPO does not suffer premium loss from time which means that it could be traded like an asset or currency. This has major applications in the futures markets (probably why CBOT is all over this). XPOs eliminating the risk of a margin call as well as the expiration risk and you have the multiple prices like in (1) above. The assumption here is that you could do an option on a "next month" contract as easily as you do a contract on a specific month. This would get around the expiration of the underlying and create a neat tool to use for long-term players.
(6) You could use XPOs to create some really powerful hybrid stock positions like combining a dividend paying asset with a call on a tech stock to give you upside on a potential Dell with the dividend payment of a Southern Company.
I feel certain that there are numerous other opportunities for XPOs especially in the currency arena. Since a yen/euro call is the same thing (when strike prices are exchange-equivalent) as a euro/yen put, the potential for triangular arbitrage alone in the currency markets is also great. You simply do yen-dollar-euro-yen trades all day long and get paid to do it... I hate when that happens!
The more I think about this the more obvious the trading opportunities become... but I'm not a derivatives rocket scientist so I'm sure that I missed many, many other opportunities to apply this XPO product class.
Man... I bet the exchanges are scrambling on this like white on rice! LEAPS on steroids? XPOs are going to be huge.
Happy trading,
TM |
