Back Fee

What Is a Back Fee?

A back fee is a payment made to the writer of a compound option when and in the event that the main option is exercised. Since a compound option is an option contract to buy another option, just the premium on the main option is paid upfront. In the event that the main option is, exercised, the premium on the subsequent choice is paid, which is the back fee.

In certain cases, a back fee may likewise allude to broadening a exotic option.

Grasping a Back Fee

A option is a derivative in view of the value of a underlying security. This contract offers the buyer the chance to buy or sell the underlying asset without committing them to do as such. Options are either call options or put options. A compound option, as the name means, would be either a call or put, and is comprised of more than one element. An option has two strike prices and two exercise dates, or a contract to purchase another option.

For instance, a trader might buy a call option on a call option, permitting them to gain conceivable exposure to the underlying asset at a less expensive price rather than buying a vanilla call option outright.

A trader must consider, nonetheless, that this transaction might require two premiums to be paid. At the point when the contract owner exercises the compound call option, the seller gets a premium on the underlying option.

In light of the compound option's strike price, this premium is called a back fee. Back fees are important to consider while dealing with compound options or other exotic options. Exotic options, including compound options, trade over-the-counter (OTC), and are consequently subject to counterparty risk.

Premium Process on a Compound Option

This is the way these premiums work. The main premium buys the call on the call. In the event that it is advantageous to do as such, the trader exercises the primary call to get the subsequent call. The practicing of the main option means the trader is presently the holder of the subsequent choice — and the primary option does not exist anymore — which requires a premium to be paid since the trader currently possesses an alternate option.

Moreover, on the off chance that the trader chooses to exercise this subsequent choice to buy the underlying asset, this would cause extra broker commissions and fees.

In spite of the fact that they generally add to the cost of an investment, back fees permit investors to exploit the movement of the underlying security, for example, a stock, without the need to put up the capital required to buy the actual asset.

Options are traded hypothetically to earn a profit as well as traded as a hedge. Involving an option as a hedge can reduce the risks associated with investing in an asset without seriously restricting the upside potential. Commodity companies frequently use options as a hedging device, alongside futures, to hedge their price risk.

Special Considerations

Certain exotic options might have a feature that permits the holder to expand the expiry date of the option. They give the holder adaptability to delay their exposure to the underlying without buying another option. In the event that the option is extended past the original expiry date, another premium will probably should be paid to cover the new term of the option.

Since options have extrinsic value — as well as possibly intrinsic value — when the expiration date of an option is extended, the extrinsic value of that option will increase. The value of that increase will be paid to the option seller as an extra premium.

Features

• Back fees are payments made to the writer of a compound option when and on the off chance that the primary option is exercised.
• In spite of the fact that they are extra expenses, back fees permit investors to exploit the movement of the underlying security.
• A compound option is an option contract to buy another option where the premium on the subsequent choice, known as the back fee, is due just when the principal option is exercised.
• These fees are important to consider while dealing with more muddled investment types including compound options or other exotic options.
• Back fees additionally let traders free from the burden of putting up more capital to invest in the actual asset.