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Why small packages are best
This article appeared in the April 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
A smaller standard contract size and more strike prices will make it much easier to use options.
ASX has dramatically reduced the single stock options contract from 1000 shares per contract to 100 shares per contract. This means that the premium per contract will be one tenth, however your exposure to the underlying share will also be one tenth of the previous exposure per contract. The changes, to be phased in during May, are part of broader ASX initiatives to strengthen its options market.
An option is a contract between two parties that gives the taker (buyer) the right, but not the obligation, to buy or sell a pre-exiting underlying asset at a particular price on or before a particular date. An option contract with 100 shares per contract means 100 shares of the underlying company on which the option is based would need to be transferred between the buyer (holder) and seller (writer) if the option is exercised.
Investors can use options to protect the value of individual shares or a portfolio; earn income; undertake to buy shares for less than their current price; lock in a buying price; and get exposure to shares for limited risk. Some investors use Put options to protect their share capital against broader sharemarket falls. ASX Exchange Traded Options has more information about the feature, benefits and risk of options.
More options series to be issued
ASX options are currently based on 1000 shares per contract, which makes them relatively expensive for high-dollar shares such as BHP Billiton and Rio Tinto. An investor would need access to $45,000 worth of BHP shares to conduct a buy/write strategy over one BHP ETO contract, based on a recent BHP share price of $45. (A buy/write is an options investment strategy in which an investor simultaneously buys shares and writes (sells) call options over an equivalent number of shares.)
By lowering the contract size to 100 shares per contract - the international standard - the investor would need access to $4500 worth of BHP shares to conduct a buy/write over one BHP ETO contract. This change will help traders who prefer smaller option exposures.
Richard Murphy, general manager, equity markets, at ASX, says the change will make the options market more attractive to retail investors. "We expect higher volumes in the options market and enhanced market efficiency from this change, which is part of a broader suite of ASX changes."
Murphy said: "When the Australian options market commenced (the first outside North America), share prices were lower and the market was mainly used by institutions. The change in contract size is a response to the general increase in the share prices of ASX Listed companies as well the strong growth in retail interest in exchange traded options. This new contract size makes the options market much more accessible to a wider group of investors. At the same time, larger investors aren't disadvantaged because fees have been pro-rated down."
Murphy says another important forthcoming change is ASX issuing more options series. ASX currently has about 20,000 series over 63 stocks. From July, ASX will begin lifting the number of series to 100,000. This means more strike prices for investors to choose from when using options contracts over those 63 stocks - and scope for greater precision in the ETO market.
Consider BHPUC7, a call option over BHP shares. It has an exercise or strike price of $47.50 and expires on April 28, 2011. A taker of such a contract will have the right, but not the obligation, to buy 1000 BHP shares for $47.50 at any time until the expiry date, when the options changes come into effect. An investor who uses this contract would have a positive view on BHP shares. By offering more contracts with different strike prices, investors could more precisely trade their view on BHP shares using options contracts.
Murphy says another key change is strengthening the obligations of market-makers in the options market. A market-maker is a firm or an individual that provides liquidity in a listed security by taking the other side of a trade when there are short-term buy-and-sell imbalances in customer orders. Market-makers earn a fee for their service and hope to profit on the bid-offer spread.
"ASX has increased the obligations for market-makers," Murphy says. "We have asked them to make more markets in more options contracts. ASX has more work to do in this regard, but the early result will be more options with matched bid and offer prices on screen, due to market-makers supporting more options contracts. Again, this will mean more options choice for investors."
A smaller change has been ASX's introduction of more precise dividend information. Dividend estimates are a pricing input that shapes implied volatility for options. This volatility, when used in an options pricing model, yields a theoretical value of the option equal the current market price of that option. Simply put, more accurate dividend estimates should mean more efficient options pricing.
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