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Equity Options for SMSFs

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As you approach retirement it's prudent that you consider reducing your exposure to riskier assets like equities and increase exposure in safer assets like cash/bonds. However with current interest rates and the benefits franking credits provide via shares it is something that is seldom done.

Overweight holdings in shares expose your retirement savings to market corrections, a lesson learned the hard way for many during the GFC.

There is a valid alternative that allows you to continue to recieve franking credits and benefit from share price appreciation but protects your portfolio from large market corrections.

Purchasing protection from the options market can help!

 

The chart above shows an increasing share market until a market crash. Purchasing index put options returns cash to a well-diversified portfolio to help offset the decline in share prices whilst allowing you the continued benefit of share ownership (dividends, franking credits, etc.)

Implementing the Strategy

Like an insurance policy there are a number of factors that influence the premium you pay for protection:

  • Portfolio Value
  • Excess (Protection level)
  • Length of Protection
  • Market Risk  

The greater the level of excess (or protection level below the prevailing market) you are willing to accept the lower your premium will be. Obviously the longer the time frame the higher your protection cost will be. Finally the more risk or volatility in the market the higher premiums will be.

The following table helps identify the approximate percentage costs of insuring a well-diversified portfolio with index put options. Note: The table assumes a market volatility level of 13% and S&P/ASX 200 Index Value of 5250

  3 Months 6 Months 12 Months
 0% Excess

 2.3%

 3.0%

4.0%

 5% Excess

0.7%

 1.3%

2.2%

 10% Excess

0.2%

0.4%

0.8%

How many options to buy?

Once you have determined the protection level and timeframe that suits your needs the final step before placing your options order with your broker is to determine how many options are need to protect your portfolio.

ASX index option contracts are worth $10 per point if the protection level you choose is 5,000 points then 1 contract is worth $50,000 if your equity portfolio is worth around $500,000 then you would purchase 10 index options. $350,000 = 7; $1,000,000 = 100 etc. 

ASX's portfolio protection calculator will help determine how many contracts to buy and at which exercise level.

What's the end result?

For every point the index falls below 5,000 points, when your options contract expires, you will recieve $10. The following table shows as the market falls losses are partially offset by cash you recieve from the options market. Whilst as the market rises you still continue to benefit from share price rises, albeit less the premium paid for protection.

 Index Value

Profit/Loss
Shares 

Profit/Loss
Options

 Total

4250

 -$100,000

 $68,100

-$31,900

4750

-$50,000

 $18,100

-$31,900

5250

 -

-$6,900 

-$6,900

5750

 $50,000

-$6,900

$43,100

6250

 $100,000

-$6,900 

$93,100 

Assume Index @ 5250 - 6 month 5% excess option bought. Portfolio Value = $525,000

Where to from here? 

ASX has a range of resources to help you better understand buying portfolio protection.

Online Protect Your Shares Course
Pre-recorded Seminars & Podcasts
Strategy Guide

Finally you will need to find a broker to execute options through. Ask your broker or your adviser about options or use our free tool to find a broker.

 

 

 

    

 

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