Australian Banks week beginning 1 Nov 2010

Options Analysis on Bank Stocks by Wai-Yee Chen

Background: NAB, ANZ and MQG (Macquarie Group) reported last week with WBC’s turn this week Wednesday, 3 Nov. Whilst CBA will not be reporting till next year.

The banks are demonstrating diverse actions as a sector, a lack of co-herent; with each falling into either of the bull, bear or neutral groups.

In the bearish camp are MQG and CBA. MQG had a good bounce on Friday due to better than expected results, but the options actions on MQG are still in the bearish camp (albeit an improved bear on Friday). The put/call ratio on traded options on MQG is around the 2 times mark (ie. twice as many puts traded than calls). Whether the improved actions on Friday will move to bullishness, is still too early to tell.

Next in the bear camp is CBA. CBA is not reporting but its options indicators are bearish. This could be due to traders switching out of CBA (which is not paying dividend just yet) to those who are (more likely ANZ).

WBC’s pattern though is less determinable. Its options actions do not have much of a weekly pattern, its positive in one and negative in another. But, with its Implied Volatility for its puts 8 times above its Historical, it will most likely fall on the bearish side this week.

In the bullish camp is ANZ. In fact it’s most bullish of the banks. This bullish switch is observed after its results.

In the neutral camp is NAB. NAB’s options actions are calmer and less extreme. It’s indicators were bearish before results but turned positive after the results. NAB will most likely stay steady at least to its ex-dividend date of 12 Nov.

This analysis may help you in positioning yourselves in the sector in the coming weeks.

(just my view, not advice)


Monday Australian Options 25 Oct 2010

Presented on Sky Business Channel (602) 10.10am

Sky News Business

1. There had been a change in OZL’s options actions last week.

Options actions is suggesting traders or investors to lock it in OZL.

Observing the call and put volumes on the stock, at face value the volume on both sides are equal for last week, but looking into daily activities threw up the switch in the stock around Wednesday. Calls had been high as the stock was travelling up and broke above the $1.60. But the especially on Friday, puts have taken over. This change of momentum coincided with the announcement of its quarterly production report middle of last week with broker downgrades at its heels after.

On Friday, there was high volume in the Nov $1.40 put, suggesting that the $1.40 level and beyond may be the level traders are expecting it to fall to. Bearish options suggestions there on OZL.

2. There was a positive development for STO on Friday late afternoon. What are options actions suggesting?

Price actions on STO were very negative, especially Thursday and Friday last week, puts have increased in large quantity. In fact the puts traded on the stock was 2 times more. This is despite the stock receiving clearance for the last hurdle of its coal seam gas project in Queensland with the approval of the Federal Government.

This could suggest that either traders were not expecting this approval or despite this anticipated approval, they were negative. One reason I could think of is the possibility of STO having to raise approximately A$1.5b in rights issue to fund its shares of the development costs.

3. There is an interesting observation in the options market which has implication on BHP.

Towards the end of last week, there’s news in the market that BHP’s bid was looking unlikely as the Canadian’s opposition calls for the rejection of BHP’s bid of Potash and it was looking likely that the state province will recommend it to be rejected by the national party. Potash shares dropped and BHP’s put/call ratios improved and turned more bullish.

Over the weekend though, there’s news in the US options market that there had been noticeable big volumes in buying of out of the money call options on Potash, suggesting an approval from the Canadian government is imminent. It may get interesting for BHP locally this week and momentum may switch back to more on the bearish side.

4. This week, NAB and ANZ will be reporting Wednesday and Thursday followed by WBC the following Wednesday, how are the options actions in these shares?

Looking at the put/call ratios on the above three banks, options market are bullish on ANZ and bearish on NAB and WBC.

Market is keener on ANZ.

What do readers say?

17 Oct 2010
I guess the co-incidences came in that much of the theory Nassim (Taleb of ‘Fooled by Randomness’ and ‘The Black Swan’) presents in his books are put to practice by the strategies in your book. M M

4 June 2010
Dear Wai-Yee, I recently purchased your book and have started reading it. I wanted to tell you that I find your explanations very clear and informative, much to my relief as a true beginner in options. I fit the “Dr Alfred” in your book. Thank you for demystifying the subject. I also wanted to tell you what a nice surprise your personal note on the front page was for me. With best wishes to you and your family. L C

18 May 2010
Hi, I have bought your book and think it is excellent. J B

11 May 2010
My first reading really convince me that your book is very practical and the
strategies are clearly explained — also with several alternative
strategies in case initial set-up goes wrong. P

8 May 2010
My congratulations on such a brilliant compilation. I have struggled so much
with the concept of options, but your book gets to the essence of what
options are all about, without the convoluted mumbo-jumbo that so many
writers use to make themselves feel important. Brilliant, brilliant,
brilliant. R K

Exercising options on RIO with CNBC

Airtime: Tues. Oct. 19 2010 | 2:05 PM ET
Chen Wai-Yee, head of derivatives, Asian desk at RBS Morgans Sydney and author of “OptionsWise” shares her strategy with CNBC’s Sri Jegarajah for investing in options in the Australian market.

1. Buying call options on RIO to benefit from potential higher share price since breaking April’s high of $81.25.

Buy Dec10 $8674 call for $2.00 (based on Rio around $83, 18 Oct 2010)

Delta of option is 0.37. A $1 rise in RIO will push option up by 37c.

Once it goes ITM (ie. above strike of $86.74, delta will be 1, $1 for $1 correlation with Rio’s share price)

2. Can XJO break and stay above the 4700 level in the next 2 to 4 weeks?

If your view is “unlikely”, then, sell the Nov 4700 call for about $650 income per contract, stripping time value off.

Risk: Strong rise in XJO above 4765 (breakeven level) and losses need to be settled by cash payment. XJO options cannot be covered by underlying shares.

Fool Proofing Your Gold Investment

Published: Sunday, 17 Oct 2010 | 9:55 PM ET
By: Deepanshu Bagchee, Senior Producer, CNBC Asia Pacific

Gold prices have been hitting record highs almost every day in recent weeks. For investors trying to figure out what to do, the situation gets more confusing when expert opinions on the outook for the yellow metal are as diverse as they are contradictory: Goldman Sachs says prices will hit $1650/oz within 12 months, but French bank Natixis says prices will actually decline in 2011 as the global economy recovers.

While Uwe Parpart, Chief Economist and Strategist for Asia at Cantor Fitzgerald, says all investors should own some gold in their portfolio, it’s easier said than done, as predicting the price of gold is just as tough as timing the stock market.

There are many ways to buy gold. You could buy an exchange-traded fund (ETF) such as the SPDRs GLD, mining stocks, futures contracts on the precious metals or the physical bullion itself. Each of these has its pros and cons.

Buying gold and storing it in a vault costs money and isn’t always practical for retail investors. Instead, John Stephenson, who’s written The Little Book of Commodity Investing, recommends investors buy shares in mining companies.

In his book, Stephenson argues that commodity ETFs, while popular, often suffer from “tracking error”. That means the ETF doesn’t always keep up with the rise in the price of the underlying commodity. For example the price of spot gold is up 26 percent this year (as of October 14th), while the Gold ETF GLD is up only 22 percent.

Buying mining shares though can mean buying execution or business risk. For example, Australia-listed miner Kingsgate recently warned that production in September was lower than expected because of maintenance at their flagshop Chatree mine in Thailand as well as heavy rain.

You could also to use options to bet on gold prices. Chen Wai-Yee, the head of the derivatives desk at RBS Morgans in Sydney and the author of the book Optionswise: How to Invest Sensibly, says this is the best way to protect your gold investments.

For example you could buy a Call Option on Newcrest. The shares are currently trading around A$42.50 ($41.92). By buying a December Call Option with the strike price of $44, you have the opportunity to buy the shares on December 23rd for $44 a share.

Let’s say, the option costs just A$0.70. If by December, gold prices have risen even further, it’s possible Newcrest shares could hit A$50. In that case you stand to make A$50 minus the agreed upon price of A$44 and the cost of the option of A$0.70. That’s a total of A$5.30. Since you buy options in sizes of 1000 units, your total profit would be A$5300.

But what if gold prices drop causing Newcrest’s stock to tumble? To protect against this you can buy a December Put Option with the same strike price of A$44. In this case if gold prices tumble and Newcrest shares fall to say A$40 (a decline of 8.5 percent), you have the right on December 23rd to sell shares of Newcrest for A$44.

How do you sell shares you don’t own? Easy, you can buy the shares for A$38 in the market and sell them at A$44. Let’s say the option costs you A$1.50, you end up with a profit of $4.50 (A$44 minus the purchase price of A$38 and the cost of the option of A$1.50). Once again since you buy options in lot sizes of 1000, your profit would be A$4500.

By buying both Call and Put Options – you’ve constructed what’s called a Straddle – with one leg getting a boost from a rally and another leg of the trade ready to profit from a decline.

Such a strategy allows you to make money whether prices go up or go down. What’s the catch you ask? Well, if prices go nowhere, that’s where it’ll hurt, as you have plunked down A$700 (A$0.7 x 1000) for the Call Option and A$1500 (A$1.5 x 1000) for the Put Option. So now your pocket is lighter by A$2200. But with so much volatility in gold it’s hard to see prices going nowhere between now and the end of the year.

© 2010

Avoid Regret With Options

By Wai-Yee Chen

Two years on since the global financial crisis which brought even the biggest names in the financial world to their knees; its adverse rippling effects is still being felt not just by investors but their families and those normally oblivious to the happenings of the financial world.

Families postponed home renovations and overseas holidays, older workers deferred retirements and others lost businesses and jobs. For investors, many have lost faith in the financial systems, some have vowed never to return to investing in shares and yet others are sitting on cash awaiting a “clearer” picture.

If you share any of these experiences, you are not alone. The feeling of lost of control, of “there is nothing I can do to change this situation”, is a common reaction by most people, who are faced with adverse situations (like the lost of large sums of money), especially in a situation they feel they cannot control (like the stock market) and their efforts in trying to overcome them seem futile. They lose heart and stop trying. This feeling of “helplessness” can be a learned behavior which psychologists call learned helplessness.

Psychologists first found this mental attitude in animals. In an experiment they conducted, animals which were conditioned (for a week) to think they can’t run away (by tying down one of their legs), were found not to attempt to run away despite being freed after the conditioning. They later discovered humans are no different! They found students who have been failing consecutively in a particular subject, for example Math regard themselves as “hopeless at Math”, even though they may be outstanding students at other subjects.

Is this common feeling of helplessness changeable? Dr Martin Seligman the psychologist who discovered this common mental trap which he called learned helplessness seems to think so. According to Seligman, we can turn those default negative attitudes or reactions to positive ones by changing the way we explain the bad situation to ourselves. Instead of these above-average students resigning to the fate of being “ hopeless at Math”, by attributing the failure to other external possibilities like the Math teacher setting unreasonably high bars for their level, they could turn that hopelessness to a constructive positive reaction of lifting their Math skills to meet the elevated standard required by the particular teacher. This is learned optimism, a conscious mental effort in reversing the more common behavior of learned helplessness.

What about investors? We have all suffered, either financial losses or the very least emotional stresses which are either direct or indirectly caused by the GFC, but as investors, how we move forward from here depends on how we explain that adverse experience to ourselves. Will we resign to fate or learn to take control?

If you belong to the latter group of wanting to take control, then options will be the tool you want to know about. You would want to know how you can protect your capital, how to have the confidence of investing without the risk losing a large chunk of your capital and how you can ensure your losses are limited to what you are willing to bare.

Options have two very powerful strengths (amongst others); one is by creating a maximum tolerable level of loss and two, is by allowing investors to test the water by capping the amount of capital at risk.

Both of these strengths of options help investors avoid regret; by not losing more than willing and by not losing out.

Strategy 1: Creating a maximum tolerable loss

This strategy helps owners of shares create a floor for their share investment by guaranteeing them an exit price.

Diagram 1 depicts the typical exposure of the owner of shares, who enjoys all upside but suffers all losses up to zero value of the share.

A shareholder’s long exposure to a share
Diagram 1: A shareholder’s long exposure to a share

Diagram 2 shows the characteristic of a put option, which rises in value when the underlying share price falls.

Put rises as share falls
Diagram 2: Put rises as share falls

Diagram 3 shows the new exposure of the share owner who has combined a share exposure with the buying of a put option.

Buying put options for shares owned
Diagram 3: Buying put options for shares owned

The share owner has created a guaranteed exit price for his share at the strike price of the put and hence constructed a floor for his exposure; whilst still being able to enjoy all upside from the ownership of the share.

Puts put you to sleep.

Strategy 2: Capping capital at risk

Options allow investors a similar exposure to a share as if they were owners of the share, only without privileges of dividends and other shareholder rights.

Buying call options over a share instead of buying the shares outright gives the investor time to consider if he should plow more into a particular investment, by putting at risk just a fraction of the cost of the share. If the underlying share proves to be a winner as suspected, then the call option investor has the right to exercise the call to buy the share at the strike price. If the investor were wrong in his judgment, then he simply walks away with a small loss. See diagram 4.

Buying call options limit losses
Diagram 4: Buying call options limit losses

Calls let you try before you buy.

Options help investors avoid regret. We regret if we lose money and we regret if we didn’t buy a winner. Buying of put options helps protect what we own and buying of call options helps us buy what we don’t already own. Used wisely, options give investors control and peace of mind. No regrets.

Published on 8 Oct 2010 in

Playing with oil via options on CNBC

Airtime: Wed. Oct. 6 2010 | 2:10 PM ET
A safer and easier way to gain exposure to the rebound in oil is to use equity options, notes Chen Wai-Yee, head of derivatives, Asian desk at RBS Morgans Sydney. She tells CNBC’s Oriel Morrison why selling a put option in Woodside Petroleum is a good bet.

1. WPL: Oil price has broken above the US$80bbl, which is a positive indication for more upside momentum.

Long the oil sector via WPL. With dividend in the next few months, take advantage of the low share price by selling put options to earn income.

Sell Nov10 $44.66 put for $1.30 (5 Oct 2010 prices)

2. ANZ: Stock up on dividend for Christmas now

ANZ will be reporting and going ex dividend early November. Dividend is forecasted to be 65c and fully franked with franking credit* of 27.9c per share. (*Franking credit is valuable to Australian tax payers as 30% tax has been paid on it)

Buy ANZ shares and sell Dec10 $25 call for 25c

Upside is capped to $25.25 ($25 strike + 25c premium).Guaranteed entitlement to dividends.