Hedge your bets with options


April 2010
By Patrick Commins

Options are probably the best-known derivative instrument and are are easily bought and sold by retail investors in the Australian sharemarket.

They can be used as hedging tools or as highly leveraged bets. Prudent investors could do worse than follow the rules laid out in the legislation for superannuation funds, says Wai-Yee Chen, the Sydney-based head of derivatives at RBS Morgans’ Asian Desk and author of OptionsWise: How to invest sensibly.

Those rules specify that super funds are not to use derivatives to gear up. Investors will fall foul of this rule if they use options – or other derivatives – to take a punt on a large move in teh value of an underlying asset. Investors are gearing because, using derivatives, they’re seeking a potential gain at only a fraction of what it would have cost to buy the underlying shares.

As mentioned previously, options give the holder the right to buy or sell the underlying asset at a predetermined price within a set period, usually about three to six months, although it can be longer.

For a call option over a listed share, you pay a premium to the seller for the right to buy the share at the exercise price before the option expires. In the case of a put option you’re buying the right to sell the share.

Example in the article can be found at the click here BHP…WOW