Reasons to invest in options traded at ASX
Investors use exchange traded options to gain exposure to a particular share’s, or sector’s movement for a limited period of time. Options are flexible instruments because they allow you to tailor the exact exposure and risk you wish to adopt for an anticipated move in the share price.
You can use options in isolation, or to complement your share investing.
There are a number of different reasons to trade in options. You may trade options in order to:
You can earn income over and above dividends by writing call options against shares you own.
As the writer of a covered call, your view would usually be for the price of the underlying shares to remain steady or fall slightly. Writing call options in this situation gives you the opportunity to generate extra returns from your share portfolio.
By writing an option you receive the option premium upfront. While you get to keep the premium, there is a possibility you may be exercised against, and have to deliver your shares to the taker at the exercise price.
Note that this strategy can also be employed with your shares bought on margin.
Put options allow you to hedge against a possible fall in the value of shares you own. By buying a put option, you guarantee the sale price of your shares for the life of the option, no matter how low the share price may go.
Without using put options, in a market downturn you can only watch your shares fall in value, or sell them.
You can consider the purchase of a put option as a form of insurance against a fall in the share price.
Leverage is a significant feature of options.
With any increase in the price of the underlying shares, the percentage return on the purchase of a call option will be greater than on the purchase of the underlying stock. Similarly, if the price of the underlying shares falls, the percentage return on the purchase of a put option will be greater than the percentage change in value of the shares.
This is because you gain exposure to the fluctuation of the underlying share price for a smaller monetary outlay than buying the shares outright.
However, just as leverage provides the potential to make high percentage returns, it also involves the risk of making large percentage losses.
By taking an option, you are effectively deferring the decision to buy (call option) or sell (put option) the underlying shares.
By taking a call option you lock in the purchase price for the shares. You pay the premium, which is only a fraction of the price of the underlying shares. You then have until the expiry day to decide whether or not to exercise the option and buy the shares.
Likewise, by taking a put option you lock in a selling price, and give yourself time to decide whether or not to proceed with the sale of the shares.
In both cases, the most you can lose is the premium you have paid for the option in the first place.