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   Installment Option
   















 

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Installment Option

Comparison of the Profit/Loss of Installment and Standard Put Options Under Two Price Scenarios (2 graphs)
An installment option has two characteristics that differentiate it from a standard option: (1) The option premium is paid periodically-usually monthly or quarterly-over the life of the option and (2) the holder has the right to stop making payments, thereby terminating the option on the due date of the first missed payment. The significance of the latter feature is that if the option is not worth the present value of the remaining payments, the holder does not have to continue to make payments. In return for the right to terminate payments, the premium charged for an installment option-if all payments are made-is greater than the premium for a standard option.
An installment option will appeal to an investor who is willing to pay a little extra for the opportunity to terminate payments and reduce losses if the investment position is not working out. Installment options may have particular appeal in markets where most or all option contracts are traded over-the-counter (OTC) rather than on exchanges. An over-the-counter option premium can be difficult to recover-even in part-if the option is out-of-the-money when an investor's viewpoint on the market price of the underlying changes. While most OTC option market-makers quote two-sided markets in their products, their bid-asked spreads may expand at times. In this context, an installment option can be a partial remedy to concerns over OTC option marketability. If an installment option is selling below the value of making an installment to keep it alive, the investor need not be concerned about losing the value of a fully-paid- for standard option. She can simply walk away from the installment option on any installment payment date. Unless the option is an American-style contract, however, it usually makes sense to continue payments on installment options which have a net present value on a payment date. Also called Continuation Option, Pay as You Go Option. See also Deferred Premium Option.

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