Front Fee

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DEFINITION of 'Front Fee'

The option premium paid by an investor upon the initial purchase of a compound option. A compound option is one where the underlying asset is also an option (i.e. an option on an option). The front fee gives the investor the right - but not the obligation - to exercise the compound option. If exercised, another fee known as the "back fee" is payable for the underlying option.

BREAKING DOWN 'Front Fee'

Compound options are used in situations where uncertainty exists regarding the requirement for risk mitigation. For example, a company may submit a bid for an overseas project. If successful, the project would generate significant revenue in a foreign currency, which may need to be hedged against exchange rate risk. A compound option would be useful in this case, because the front fee payable would be lower than the premium payable on a foreign currency option contract (which is a contingent liability in any case).

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RELATED FAQS
  1. My brokerage firm won't allow naked option positions. What does this mean?

    A naked position refers to a situation in which a trader sells an option contract without holding a position in the underlying ... Read Full Answer >>
  2. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
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    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How do I determine the breakeven point for a short put?

    The breakeven point for a short put is the strike price of the option minus the premium. Selling puts is a way for traders ... Read Full Answer >>
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