What it is:
A compound option is the opportunity to buy or sell an.
How it works/Example:
Let’s assume John Doe buys a call. This arrangement is called a compound option -- that is, it is an option to purchase an option.
Now let’s say John Doe wants to exercise the call on the option. Now he must pay the premium on the second option (the option to buy 100 of Company XYZ at $25 per share). This second premium, called the back fee, is $3,900.
Why it matters:
Many investors know that they don’t always have to make outright purchases or sales of securities; they can also use and calls. But few investors know about compound options, which can be very useful but carry .
Back fees are very much like fees paid to extend the life of an . Though they represent an added expense, the broader picture is that the compound options they associate with a way for investors to "ride" a without as much capital as would be required for buying or selling the stock outright. This does not come without risk, however.