Used wisely, options have the power to protect, grow or even diversify your position. From Puts and Calls to more advanced Condor, Butterfly and Split Strike strategies, options can be investment heroes in disguise. And you can learn how to make them work for you at the educational ASX webcast.
Mitigate risk in a falling market
in a falling market
Enhance profit in a rising market
in a rising market
Generate income in a flat market
in a flat market
Taking options is a relatively low-risk trading strategy. If the underlying securities do not behave as you expect, you can simply allow the option to expire. The most you can lose is the initial premium you paid for the option.
Some investors use options to defer the decision to buy or sell shares, a strategy that allows you to see how the shares behave before making a commitment either way. Again, if you decide not to exercise the option, the most you can lose is the initial premium – normally only a fraction of the total share price.
Options can be used to offset potential falls in share prices by taking put options giving you the right to sell your shares at a pre-set price for the life of the option, no matter how low the share price may drop.
Writing options can be considerably riskier than taking options as even though your premium is fixed there is the potential to incur losses greater than that amount. For example, if the market moves against your position, your losses can escalate quickly. Writing call options if you don’t own the underlying securities is particularly risky, as you will have to provide the underlying securities if you are exercised against.
Options have an expiry date, and as such decrease in value over time. The rate at which options decrease in value accelerates the closer you get to the expiry date. Additionally, market factors such as interest rates and market volatility can affect the value of an option.
If you are writing options, ASX may require you to provide extra security to ensure that you can meet your obligations if your options are exercised. This will require you to pay additional funds to maintain your position. If you cannot do this, your broker may close out your position and you will be liable for any resulting losses.
Options trading strategies can be complex especially if you need to take offsetting positions. Doing this can be a risk, in itself, if you do not fully understand this strategy. Before trading options you should ensure you fully understand options and their risks, and consult your broker.
Graham is the Manager of Equities Derivatives at ASX. He started on the options trading floor as a board broker in 1995 and then worked on both institutional and retail desks until 2001. Among Graham’s key responsibilities is educating investors and advisers on a range of ASX products, including options.