Investing in options

Exchange Traded Options (ETOs) are one of the fastest growing products on ASX with over 100,000 contracts traded daily. Once thought of as only for speculators, today they are just as likely to be used by long-term investors managing risk, investors buying shares on margin or in Self Managed Super Funds (SMSF).

Options can be used in a variety of ways to profit from a rise or fall in prices. The most basic strategies employ put and call options as a low cost means of getting exposure to shares or an index. Options can also be used to offer protection from a decline in the market price or as a hedge against rising prices. They can enable you to buy shares at a lower price, sell shares at a higher price, or create additional income against a portfolio. You can also use option strategies to profit from a move in price regardless of market direction. When used as part of a portfolio, options can reduce volatility and enhance returns. This versatility makes options very popular with investors looking to trade short-term moves as well as build and protect long-term wealth.

Reasons to invest in options

1. Protect your shares from a fall in price
2. Earn income against shares you hold or are looking to buy
3. Increase your returns through leverage
4. Diversify your portfolio with options

1. Protect your shares from a fall in price
   Put options allow you to protect the value of particular share or your portfolio against falls. By buying a put option, you lock in a selling price for the underlying shares or the value of a portfolio at a level represented by an index, for the life of the option. You can consider the purchase of a put option as a form of insurance however unlike an insurance policy the term of the protection can be for short periods such as a week or a month, as well as 6-12months. Any time you no longer consider it necessary to protect the value of individual shares or your portfolio the options can be sold.
   
   
2. Earn income against shares you hold or are looking to buy.
   Writing or selling options against stocks is a popular strategy used to generate income over above dividends. Typically investors will write call options against shares they own either outright or on margin to increase returns. In some cases investors do not want to sell their shares so will sell options at levels above the current price of the shares in expectation that the shares never reaches the level at which they would be required to sell. For others, selling call options is a useful mechanism for locking in a selling price; usually at or slightly above  the current price and getting paid a premium for undertaking to sell their shares.
   
   In the same way investors that sell call options are paid a premium for undertaking to sell shares, selling put options also generates premiums. In the case of selling a put option the obligation is to potentially buy shares if the shares fall below the price at which the seller is undertaking to buy them. In this way selling put options is a way to being paid to buy shares at a lower price they are currently worth.
   
   
3. Increase your returns through leverage.
   One of the main reasons options are so popular is the leverage they provide. Costing no more than 2-5% of the purchase price of the underlying shares, it easy to get exposure to many more shares than buying the stock itself or even buying on margin(margin lending). 
   
4. Diversify your portfolio with options. 
   Going  hand in hand with the lower dollar cost of options is the ability to diversify more widely.  Investors that could not otherwise afford to buy 1000 shares at $50 in one company and 1000 shares in another at $40 can however get exposure and diversify their portfolio using options, albeit for a limited time only.
   
   For more information on the benefits of options, please refer to the ASX explanatory booklet Understanding Options Trading.

Remember you need to set up a client account or trading account and enable options on that account before you can start trading options. This can take up to a week to finalise.

See also; Buy Write, Covered Calls, Renting Shares.