When I was a Stockbroker I used to deal in Exchange Traded Options; so I thought I’d outline what they are and how they can actually be used by financial advisers when developing strategies for ordinary Australians.
In simple terms, an Exchange Traded Options (ETO) is in the form of either a Put or a Call which simply means you either have the option (but not the obligation) to sell a share at an agreed price (Put) or buy a share at an agreed price (Call). In each case, you have an agreed price and a defined term during which the transaction can be exercised.
For example, say National Australia Bank shares are currently trading at $28.27. Now, I either think these shares are going to go up or I think they are going to go down. If I think they are going to go up, I can buy a Call option on a block of them at, say, $30 per share. If the price subsequently moves to $40 (within my defined term) I can exercise my option by calling for the shares at $30 and immediately selling them for $40 thereby making a $10 gain on each share. If I think they are going down I could buy a Put option at, say, $26. If the price subsequently moves to $16 I can exercise my option and the counter-party (the person on the other side of the agreement) must purchase them at $26 whilst I can buy them for just $16. Again, a $10 gain per share.
This arrangement allowed me to trade in shares for a fraction of the outlay involved in buying the actual shares. However, exchange traded options also allow investors to virtually eliminate risk on share investments. I’ll explain more about 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.
David Heycock, Omnia Group