Turn insights into profits

If you're an active trader with strong opinions about the future market movements, Exchange Traded Options (ETOS) could be the ideal way to profit from your insights.

An option gives you leveraged exposure to a parcel of shares or, in some cases, an index. If the underlying shares rise or fall even slightly, then the corresponding options can move a long way in a short time.

That means options offer the potential for large gains with only a small upfront investment, in both rising and falling markets. But like any leveraged investment, they also come with significant risks, so you need to go in with your eyes wide open.

More risk-conscious investors can also use options to protect their existing share holdings for a relatively small outlay. And both individual investors and self-managed super funds (SMSFs) can use options to generate extra income from an existing shareholding by writing covered calls.

Options are not available to trade through InvestSMART.

What is an option?

An option is a contract between a buyer (or taker) and a seller (or writer). As the buyer, you have the right, but not the obligation, to buy or sell a bundle of shares at a set price, on or before a set date. In exchange for this right, you pay the seller a premium. A Call option gives you the right to buy, while a Put option allows you to sell.

Alternatively, you can choose to become an option writer, earning premium income. In that case, you run the risk that the buyer might exercise their right to sell to you or buy from you.

By combining multiple options with different prices or expiry dates, you can create sophisticated strategies for different market conditions.

Three option strategies

  1. Profit from your insights. Options are a low-cost alternative to trading shares directly, allowing you to profit when your view of short term market movements proves correct. But remember, options typically expire within three months - so if you're not proved right in that time, your investment may come to nothing.
  2. Manage risk. You can use Put options to protect the value of an existing shareholding by locking in a sale price. If the market falls, you don't even need to sell your shares - you can simply sell the option and pocket the difference.
  3. Earn extra income. Both individual investors and SMSF can earn extra income from a share portfolio by writing a covered call, which gives the buyer the right to buy your shares at the price you specify. While this strategy can help you substantially increase your returns over time, you do run the risk that you'll be forced to either sell your shares or spend money to exit your position if the market rises.

Understanding the risks

Options come with significant risks, so it's important to do your research before you trade. The ASX's options pages are a good place to start. If in doubt, seek professional advice.

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