Options are usually issued over shares or market indexes. Call and put options are available for both asset types. A third, more specialised type of option called a low exercise price option (LEPO) is also available.
Equity options are issued over shares in individual companies allowing you to trade based on your view of that company’s likely share performance.
For example, you might trade call options if you think the company’s share price will increase, or put options if you think its share price will fall.
The value of an equity option varies according to movements in the value of the underlying shares. Equity options are only issued over shares in ASX-approved companies. Options are usually exercisable on or before the expiry date.
Equity call option holders do not receive dividends or franking credits, nor do they have voting rights in the company. A call holder must exercise the option and take ownership of the underlying shares to be eligible for these rights.
Put option holders only receive dividends or franking credits if they hold the shares that relate to the option (i.e. ‘covered’ positions).
Index options give you exposure to a market index, such as the S&P/ASX 200. They offer similar benefits to options traded over shares in individual companies with the added benefit that they offer exposure to the broad range of securities that make up an index.
You can use index options to trade based on your view of whether the index as a whole will go up or down.
As with equity options, both call and put index options are available. However, there are a few differences:
- index options can only be exercised on their expiry date (can still be closed-out?
- they are cash-settled, meaning you will receive or pay a cash payment on exercise, and the settlement price is based on the opening price of the index on the morning of the expiry date
- the strike price and premiums for index options are expressed in index points, rather than as a cash value.
Low exercise price options
Low exercise price options (LEPOs) are a specialised form of option that closely track the price of the underlying stock or index. LEPOs do not require you to pay an upfront premium. Instead you make margin payments throughout the life of the LEPO. LEPOs are available over indexes and company shares. They are only available as call options.
As suggested by the name, the exercise price is typically set very low (typically A$0.01). Because of this, LEPOs trade for large premiums. LEPOs are only exercisable at expiry.
When you buy or write a LEPO, you do not pay the full amount of the premium upfront. Instead, you pay or receive margin payments during the life of the LEPO until the LEPO is closed out or exercised. These margin payments can be offset against other exchange-traded option positions.
When you take a share LEPO, you obtain the right to buy an agreed number of shares (100 shares per contract) at a specified future date in return for the payment of the exercise price (1 cent) and the original premium at which the LEPO traded.
Buying a LEPO is similar to a forward purchase of shares, while selling a LEPO is similar to a forward sale of shares. Using a LEPO can be a cost-effective alternative to borrowing to fund a share purchase.
Index LEPOs give forward-style exposure to the sharemarket. Like traditional index options, they are cash-settled and the premium is expressed in index points.
Buyers of index LEPOs notionally buy the underlying index on the expiry date. Sellers of index LEPOs commit to notionally selling the index on the expiry date.
Buyers make a profit if the level of the underlying index on the expiry date is greater than the premium. Sellers make a profit if the level of the underlying index is less than the premium.
Subject to regulatory approval (expected go-live 1 Decmber 2015)
Total Return Single Stock (TORESS) LEPOs have two distinguishing features which differentiate them from standard LEPOs currently available to trade on ASX.
- The first feature is that ordinary cash dividends paid on the underlying shares are adjusted via a cash transfer of an amount equal to the dividend between the option seller and buyer. This feature aims to ensure that neither the buyer nor seller are disadvantaged by a substantial change to expected dividend payouts from the company whose shares the options are listed over. This can occur for standard LEPOs where there is no adjustment and expected dividends are reflected in the market price. Only the interest rate component is unknown.
- The second feature is that the options will be cash settled upon exercise as opposed to physical delivery.
TORESS LEPOs will be differentiated from standard options though a different security code. Generally the first two characters will denote (map to) the underlying ASX code eg. BH for BHP, the third character will be a set numerical value (I.e. 8), the fourth, fifth and sixth characters will be similar to standard options being the clearing codes randomly assigned by ASX.