An option is a contract between two parties giving the taker (buyer) the right, but not the obligation, to buy or to sell a parcel of shares at a specified price on (or before) a specified date.
There are two types of options traded on the ASX: call options and put options.
- Call options give the taker the right, but not the obligation, to buy the underlying shares
- Put options give the taker the right, but not the obligation, to sell the underlying shares
You can trade options over most of Australia's largest companies, including News Corporation, Telstra, BHP Billiton and the major banks.
Example of an options adjustment in regards to a Rights Issue / Corporate Action event:
The ASX Education section provides access to interactive and educational material covering various topics, including Options.
Advantages of options trading
A simple strategy is to use put options which allow investors holding shares to hedge against a possible fall in their value. This can be considered similar to taking out insurance against a fall in the share price.
Time to decide
By buying a call option, the purchase price for the shares is locked in. This gives the call option holder until the expiry date to decide whether or not to exercise the option and buy the shares. Likewise, the buyer of a put option has time to decide whether or not to sell the shares.
Ease of trading
The ease of trading in and out of an option position makes it possible to trade options even if there is no intention of ever exercising them. If an investor expects the market to rise, they may decide to buy call options and vice versa. Either way the holder can sell the option prior to expiry to take a profit or limit a loss.
Leverage provides the potential to make a higher return from a smaller initial outlay than investing directly. However, leverage usually involves more risk than a direct investment in the underlying shares. Trading in options can allow investors to benefit from a change in the price of the share without having to pay the full price of the share.
ASX's options market allows investors to build a diversified portfolio for the same or even lower initial outlay than purchasing shares directly.
Share holders can earn extra income over and above dividends by writing call options against their shares. By writing an option they receive the option premium upfront. While they get to keep the option premium, there is the possibility that they have to sell their shares to the buyer of the option at the exercise price. This is called a 'covered write' strategy.
- Options are not without a higher level of risk and therefore may not be appropriate for everyone.
- Time value erosion may adversely affect the price of bought option positions even if the underlying instrument moves in the desired direction.
- As options can be used as a leveraging tool, losses may be magnified and created quickly.
- Options have a finite life and need to be monitored closely, with a great deal of observation and maintenance.
The power of options lies in their versatility. They enable you to adapt or adjust your position according to any situation that arises.
Contact your Morgans Perth adviser to discuss whether an options strategy is appropriate for your own personal circumstances and needs.