A front fee is the initial payment made by an investor when he purchases a compound option. Compound option is the term given to what is essentially an option on an option. That is to say, the trader may wish to buy or sell an option at a future date, and the front fee is what he must pay in order to have that opportunity. The four types of compound options are:
For example, an investor sees a company stock valued at $24 per share, and he believes the price will rise dramatically, but is not certain. He decides that if the price reaches $30 per share, then his prediction is probably correct, and the price is likely to continue rising well beyond $30. In this case, he can decide to purchase a compound option – a call on a call, which will give him the right to purchase, say, 100 shares, if the stock reaches $30 by a particular date. December 31. He would then pay a front fee, for example, $500, thus giving him the right to make that purchase if the stocks hit $30. If he chooses to exercise his option and buy 100 shares when the price reaches $30, he would pay the full $3,000 (100 shares x $30/share). The $3,000 is called the back fee. The front fee does not obligate the trader to exercise the compound option, but it does allow him to do so.
The ability to place a compound option gives traders leeway in future decisions. The advantage to compound options is that if a trader believes prices will rise (or fall, as the case may be), but is not certain, he has the opportunity to trade if he proves to be correct. He will pay more on the compound option than he would have in a single option (front fee – $500 + back fee – $3,000), but if his projection is correct, then his profits should outweigh that additional cost. Without paying the front fee, he may not even have the ability to purchase the shares. The disadvantage is that if he chooses not to exercise the option, he has paid the front fee with no return.
*Please note: Fortrade does not offer options.