For the average person, the share market is the most visible form of financial market, and perhaps the only market in which they have some direct contact. The options market is usually seen to be too risky or too complicated. Well, the truth is, the options market provides many benefits to share investors and traders, for those that spend some time learning what options have to offer.



Options warrant attention

There have been options traded on the Australian share market since the 1960's, and they are still big business today. Exchange traded options (ETO's) became very popular in the 70's, as these allowed a greater number of traders to enter the market. So why are options so popular? Options provide a variety of benefits over ordinary shares, which, when used correctly, can drastically reduce the risks involved in owning shares.

But before we understand how options can help us, it is necessary to know what an option is.

An option is a contract between two parties regarding the price direction of a particular share. One party believes the price of the share is going to rise in a certain time, the other believes the price is going to fall in that time. Depending on which direction each party believes the price is going to go, they will either buy or sell an option.

The person who purchases the option has the right but not the obligation, to buy or sell a set number of shares, at a pre-determined price on or before a set date in the future.

As you can purchase the right to either buy or sell shares, there are thus two types of options, a Call option and a Put option. A Call option gives the owner the right to BUY shares, whereas a PUT option gives the owner the right to SELL shares.

For example, let's say that you believe that XYZ limited shares are going to rise in value over the next month. They are currently trading at $1.00 per share. You can either purchase 10,000 shares right now, and invest $10,000 or you could buy the right to purchase them at $1.00, one month from now. For this right, you will pay premium. The premium you will pay will be approximately 4 cents per share. Therefore, you will invest $400 ($0.04 x 10,000).

If the share price of XYZ goes up to $1.20 in the month, then you can exercise your right to buy the shares at $1.00. You will therefore make a profit per share of 16 cents ($0.20 profit – $0.04 premium). With 10,000 shares, you will make a profit of $1,600, or 400% on your original investment.

Had you invested $10,000 in the first place, you would have only made $2,000, or 20% profit.

At the same time, had the price fallen below $1, say to $0.80 cents, then you would not exercise your right to buy the shares and you would walk away, losing only your $400. You have the option to buy the shares, not the obligation. But, if you had bought the shares, you would have lost $2,000, or 20% of your original capital.

Options can act as a risk management tool. That is, you can limit your losses, whilst still taking advantage of the share price increases.

One of the major advantages over purchasing shares outright, is that with options, you can also buy the right to sell, in case the share price falls. Therefore, you can profit from the market if it is rising or falling in value!

Options are a little more complicated than shares to understand, but with a little practice, you will discover that options are a fantastic financial instrument. With options you can “insure” your share portfolio, generate a monthly income and return 100% and more on trades. You just have to know how. The Platinum Pursuits report will feature many articles on options and we welcome you to attend our monthly seminars, where we will teach you how to profit with options.