In the last newsletter I explained how ‘Put and Call’ options can be traded on the Australian Stock Market. Calls mean you have the option to buy shares and Put mean you have the option to sell shares – both at a defined price within a defined time.
Easy right? Well not exactly. The whole issue is about timing. Back in 1990 I was trading an account for a major client and I had calculated that Newscorp was seriously under-priced. I therefore bought my client $50,000 worth of call options at an exercise price close the the current trading price at the time and guess what, I was completely correct; a while later Newscorp shares went for a massive run with the price climbing over $15 per share. Problem was the run occurred 2 weeks after my option period expired. My strategy was spot on but my timing was a little off. My client’s options therefore expired worthless. Instead of making hundreds of thousands he lost $50,000 and I lost the account. No prizes for second place in this game.
In addition, you can either sell Put and Call or buy Put and Call. Thus if you sell, you have a reverse effect with your holding. That is you can sell the option to buy or sell the obligation to sell. Confusing I know.
Here’s a summary of how each strategy works:
- Buying a Call – You have the right to buy a stock at a predetermined price.
- Selling a Call – You have an obligation to deliver the stock at a predetermined price to the option buyer.
- Buying a Put – You have the right to sell a stock at a predetermined price.
- Selling a Put – You have an obligation to buy the stock at a predetermined price if the buyer of the put option wants to sell it to you.
So how could an ordinary person use ETOs? Well, a simple strategy would be what’s called a ‘Straddle’. This is where you buy a Put and sell a Call on the same stock. I’ll explain how this works in our next Newsletter but, of course, any specific strategy of this kind would need to be addressed by your licensed financial adviser.