What is a Deferred Payment American Option?
A deferred payment American option works differently from regular American options. When someone buys this special type of option, they get a discount on the price (premium) they pay upfront. Here’s the trade-off: even after they exercise the option, they need to wait until the original end date (maturity) to get their money.
How Does It Save Money?
People who buy these options pay less because the seller gets to keep using the money longer. Think about the normal way options work – when someone exercises an option, the seller has to pay right away. But with a deferred payment option, the seller can hold onto that money until the original end date. This extra time with the money is valuable to the seller, so they charge less for the option.
Example to Make It Clear
Let’s say Mary buys a regular American option that ends in 6 months. If she exercises it after 2 months, she gets her money right away. But with a deferred payment option, even if Mary exercises after 2 months, she needs to wait 4 more months to get paid. Because Mary agrees to wait, she pays less at the start.
Trading Places
These options aren’t bought and sold on regular exchanges. Instead, they’re traded “over-the-counter” (OTC), which means buyers and sellers make deals directly with each other. This lets them create custom arrangements that work for both sides.
Why Choose This Type?
Buyers might pick these options when they:
- Want to pay less upfront
- Don’t need the money right away
- Can wait until the end date
- Like having more flexible trading choices
Sellers might like them because they:
- Keep the money longer
- Can use the funds for other things
- Have more time to plan payments
- Can offer lower prices to attract buyers
Money Management
Both sides need to think carefully about their money. Buyers must make sure they’re okay waiting for payment. Sellers should use their extra time wisely since they’ll need to pay eventually.
