What Is a Perpetual Option?

A perpetual option is a non-standard, or exotic, financial option with no fixed maturity and no exercise limit. While the life of a standard option can vary from a few days to several years, a perpetual option (XPO) can be exercised at any time without expiration. Perpetual options are considered an American option, whereas European options can be exercised only on the option's maturity date.

These contracts are also referred to as "non-expiring options" or "expirationless options."

Understanding Perpetual Option (XPO)

An options contract gives its holder the right, but not the obligation, to purchase (for a call option) or sell (for a put option) a specific amount of the underlying security for a predetermined (strike) price at or before the option's expiration. A perpetual option grants the same sort of rights without expiration.

Perpetual options are technically classified as exotic options since they are non-standard, although they may be viewed as "plain vanilla" options since the only modification is the lack of a determined expiration date. For some investors, these represent an advantage over other instruments (especially when dividends and/or voting rights are not a high priority) because the strike price on a perpetual option enables the holder to choose the buy or sell price point instead of having to select a singular stock price. In addition, XPOs can be preferable to standard options because they eliminate expiration risk.

While perpetual options have some favorable features and have been the focus of some interesting academic work in financial economics, the practical use of XPOs by traders is very limited. In fact, no registered options exchanges list perpetual options in the U.S. or abroad, so if and when they do trade they will occur in the over-the-counter (OTC) market. One example of an exotic OTC option that combines a perpetual option with a "lookback" feature is the so-called Russian style option.

Pricing a Perpetual Option

European options are priced using the Black-Scholes-Merton (BSM) model, and American options that have an early exercise feature are priced typically with a binomial or trinomial tree model. Having no expiration date, perpetual options are somewhat different to price, often using a Martingale model.

In order to price these options, the conditions for when to optimally exercise must be established, which could be defined as when the underlying asset reaches the optimal exercise barrier. This barrier price is the optimal exercise point and is defined mathematically as where the present values of the option's price and the payoff converge.