Listed options are traded on Australia’s stock exchange that can be bought or sold via an online broker. Meaning that it doesn’t require face-to-face negotiations like over-the-counter derivatives do.
Options that you can trade on the Australian Stock Exchange
These give the buyer the right, but not the obligation, to buy a share at a fixed price (the strike price) until a specific date (exercise period). An option becomes more valuable as it approaches its expiry. The buyer must pay for this privilege; this is called the premium. For example, if an apple farmer owns 200 shares in their company and decides they don’t want them anymore, they may sell those shares as ‘calls’. Somebody else now has the right (but not obligation) to buy those shares from them at $100/share any time before the option expires.
These give the buyer the right, but not the obligation, to sell a share at a fixed price (the strike price) until a specific date (exercise period). An option becomes more valuable as it approaches its expiry. The buyer must pay for this privilege; this is called the premium. For example, if an apple farmer owns 200 shares in their company and decides to own them forever, they may sell them as ‘puts’. Somebody else now has the right (but not obligation) to sell those shares to them at $100/share any time before the option expires.
Calls and puts are usually traded over-the-counter derivatives but can be found on the Australian Stock Exchange. You can use them to protect against or speculate on movements in the price of an asset, and they are often subject to leverage. Options can be bought and sold through Saxo Bank.
Options have an exercise period
Firstly, you should know that options have an exercise period, meaning they only exist for a certain amount of time. The longer the exercise period, the more expensive buying or selling an option because you’re paying for more time.
For example, ABC Company announces the release of their earnings in 3 days, so traders start buying ABC Company’s call options. They predict a significant movement in the price up or down based on the earnings release. They want to take advantage of this by buying these cheap call options with a low price and waiting until just before the earnings release date, then exercising their right to get shares at a lower cost than what they can get on that day from everyone else who didn’t plan.
If the price is under the strike price, it makes sense to exercise an option because you can buy shares at a lower than market rate then sell them immediately above your purchase price for profit. If the price is above the strike price, it makes more sense not to exercise your right and let it expire (which means what you paid for that right has now gone to waste).
They are like insurance contracts
Options are like insurance contracts where you pay an insurance premium (the option’s price) upfront. If something terrible happens, you get to make money off it. If something good happens, you lose the insurance premium you paid for that contract.
Options are also insurance contracts where risk is transferred from seller to buyer of that contract. The purchaser pays a premium for this protection which they hope will make them money if something goes wrong, while the seller hopes nothing goes wrong, so they don’t have to payout.
Options use leverage
With options, you only need to use a small amount of money to control a large number of shares. Meaning you can use them as a form of leverage that many traders use to profit from the change in price from those shares. You can do this by buying or selling those options with little upfront capital with the hope that it will end up with you having more money than you started with through your profits and losses.
When using margin to buy an option with leverage, this is called ‘buying on margin’. Using collateralised cash borrowings to sell an option with borrowed money is called ‘selling on margin.’