Navigate the new at CPA Congress 2010

There’s a new financial landscape across the globe and “navigating the new” was a potent theme for CPA Congress 2010. Key speakers shared their insights on how to forge ahead in the post-GFC world

by Jane-Anne Lee

The new view for investment

Where people would once look at the upside, now the first questions investors need to address are what sort of risk accompanies this investment and what is the maximum tolerable loss, according to Wai-Yee Chen, the head of Derivatives – Asian Desk Sydney for RBS Morgans, and the author of OptionsWise: How to invest sensibly (Oex Publishers).

“What was viewed as safe before cannot be taken for granted as safe any more,” she says. “One common way for people to come to terms or face such challenges is to run to the other extreme – not investing, sitting on cash, too afraid to move. But that may not be the best thing to do, even if it is an understandable reaction if one lost a big chuck of their investments.

“The new way of investing is all about preserving capital. I think the change in mindset in permanent, which is not a bad thing,” she says.

“This is a good time for people to do things differently, to re-evaluate risk as part of  the new landscape when looking at investment potential. The other new way is to use options which can be used for hedging – it’s like buying insurance for shares – to generate an income stream other than dividends and to purchase and sell shares.

“The hope of professionals is that as we emerge from the economic slowdown, we learn new skills and new ways to protect capital.” However, Chen urges caution about going too far. She says we also need to “learn not to regard risk as the enemy.” “If people can have that mindset, then they will do well no matter how the market goes.”

The rest of the article can be found here CPA’s Navigate the New, December 2010


Any bubbles at Foster’s this Christmas?

 Sky News Business Interview 20 December 2010


Foster’s share price (FGL.ASX) has been doing it tough since late October and has lost almost 10%  (see chart below from the ASX, it has fallen from $6.00 to $5.50). Would this festive season give the stock a boost?


 The chart of daily prices over 6 months for security FGL




Well, looking at its options actions, it does look like some bubbles are developing.

 A combination of  high Aussie Dollar and weaker volumes have seen the share price falling.  Transformation of its beer and wine divisions though are on track, but has definitely taken time and a toll on its share price.   

After its once false-start recovery at the $5.80 level, this time at the $5.50-$5.60 range, it may just do it. Its put/call ratio has had an improvement last week and both volumes traded and Open Interests are displaying positive signs. There are large volumes on the call side opened at the Jan11 $5.75 and $6.00 strikes and there had been active trades in the Mar11 $6.00 Call as well. 

For investors who take a view to March next year, buying the shares will entitle them to the 12c dividend to be ex’d at third week of February and to enhance the yield further, write a call over the shares.

It is a season to be Merry and I hope it will be extended to Fosters’ shareholders too!

Merry Christmas Everyone!



CNBC – Protecting your QRN till loyalty shares

Hedging Against the Downside  14 Dec 2010

    Discussing how investors who subscribed to QR National’s IPO can protect their holdings from downside risk while waiting to get their royalty shares in December 2011, with Chen Wai-Yee, head of derivatives, Asian desk at RBS Morgans, speaking with CNBC’s Oriel Morrison.

1. Buying a Dec11 $2.60 put for 14c (with QRN trading at $2.82 today)

– protects you till loyalty shares are allocated on 7 Dec 2011 (today’s value is $1400 if you are entitled to the maximum amount of 500 shares)

– Creates a floor of $2.46 for your shares (close to the $2.45 retail investors paid for)

The guaranteed exit price comes with a price. To claw some of the 14c back, there’s is another strategy to consider.

2. Sell covered calls over shares

Keeping it short dated with the opportunity to re-write and at a gradually higher price (if share continues to go up)

Sell Feb11 $2.90 call for 7c.

With the 7c call option income plus the 6.5c yield for the full year from the stock(3.7c projected to be paid in September 11), that’s almost recovering the 14c paid for protection.

Use of options allow investors the opportunity to invest with confidence. Combining the two strategies give investors peace of mind in holding the shares and at the same time opportunity to do better than the forecasted 6.5c  per annum dividend income from the stock.

Options Question: Aussie XVI is at 12.16, what does it mean?

Options Question:

Hi Wai-Yee, I noticed the Aussie VIX dropped down to 12.16 today. How long could it stay at these levels ? From our previous talks I have been watching it each day and see its come down from 20 last month. What are your thoughts about the Aussie VIX and the ASX 200. Kind Regards Jon.

Wai-Yee replies:

Hi Jon,

You have brought up a very interesting topic. 

At a reading of 12.16 on 10 Dec, the XVI was at an all-time low! The obvious flow-on question then is, what does it mean for the XJO, which you have asked also.

 What is XVI?

 The XVI (or short for the S&P/ASX 200 Volatility Index), for those who have not been following, is the Australian VIX Index, launched by the ASX not too long ago. It is liken to the popular CBOE VIX index which is widely followed as the “fear gauge” of the stock market. VIX or XVI for us, measures the volatility of the Index. The market convention is that if volatility is high ie. VIX is high, then there is increased uncertainty in the market and markets tend to fall, hence fear is high and vice versa.

 Now, what we have is an all-time low XVI, which means there is a lack of the fear factor in the market currently. Does it mean that the market is bullish? This is what we will try to find out by looking at the XJO from different angles from the options perspective.

 We experienced the most recent high of 4815 on the XJO on 5 November. On that day, the XVI was at 18.29. On 10 Dec, despite the XJO having a reading of only 4750 (high of the day), the XVI was at the lowest point of 12.16. If I could show you the chart (coundn’t get it posted), you will see two spikes, the latest one with a lower peak, at the moment. This is indicating that the market is now more sanguine than a month before, eventhough we are not quite at the last high of above 4800 level. This is a bullish indicator.

Another indicator to look at is the Put/Call Ratio.  What is Put/Call Ratio?

 It’s a measurement of the number of puts versus the number of calls traded. It’s a division of Puts over Calls. A reading of greater than 1, signify more puts bought than calls on the underlying.

For those who don’t follow the Put/Call Ratio on XJO, it’s quite common for the XJO’s ratio to be greater than one, as institutions or investors buy the XJO Puts for portfolio protection.

The Put/Call Ratio for the XJO at the week ending 5 November (when the XJO hit a high of 4815) was at 1.83. Last week, when the XVI was at the lowest point of 12.16, the Put/Call ratio of the XJO has reduced to 1.17. Again, if I could show you the chart, you will see the gradual decline of the ratio in the last month, though the market is still not at the high it was a month ago. This is a very bullish indicator for the XJO. 

The reading of the current low 1.17  is indicating that institutions/investors/traders are taking positions in the market without hedging or not taking as much protection as normal. This is demonstrating that they have a bullish view of the market and do not think protection necessary at this juncture. Whether this turns out to be a prudent stand, we shall see, but this is the thinking of the market at the moment.

 The two indicators above are signalling to us that market participants do think the market is heading higher. If I were to cast a larger net and look at the market  as a whole as well (a part from options indicators), where the market has been and how it has been performing, I do agree with the general consensus, that we are heading higher for now; but, it would do so at a snail pace, in contrast to a rocket up performance. So, patience is required to make money in this market.

 Well, as stock markets are prone to doing what we don’t expect it to do, do check in again, for changing market conditions.

I hope this has been helpful, but remember, this is only my view, it is not necessarily RBS Morgans’ and that I can’t give advice in this forum and I can be wrong!

Have a Merry Christmas and enjoy the ride up!


Be free, with options


Using options correctly can provide a great kicker to an ordinary share-based portfolio. By OptionsWise author Wai-Yee Chen

To live is to have regrets. Some of us regret the choice we made in the university we attended (“If only I have gone to an Ivy League School”), the courses we took or did not take (“If only I had studied psychology”) or the job we turned down (“How my career would have turned out”), the relationships we chose to hang on to when it was time to let go and the stocks we chose to buy and sell – at the wrong prices.

Our brains torment us with negative choices we made with the imagination of the alternatives. The emotion of regret is found by many researchers to have magnified and in some instances caused stress and depression, while in others it creates a lower quality of life.

When faced with high-risk decisions (like investing), we tend to look back and choose the option that produced the least regret (or mental stress), even if it is known to return a lower level of satisfaction. On the other hand, another study found that regrets can produce favorable results and it’s not without benefits. Regrets can help us make sense of what went wrong and find a solution that may best overcome it.

There is a group of investors that have moved their investments to cash or fixed-interest products and perhaps even regret investing in the share market in the past two to three years. While wanting to participate in the “kicker” that shares can give them their past experiences are tearing them in the opposite direction.

However, if this group of investors subscribe to the finding that regrets can produce favorable results and may even allow them to grow from past experiences to considering other investing alternatives; then the combination of those scars (or past experiences) with the use of option strategies alongside their share portfolios, will help them move forward. 

The use of options for a portfolio investor gives the investor the opportunity to consider his/her alternatives, buying time before spending a big chunk of capital and yet reduce the effect of a wrong decision and hence the emotions of regret.

The diagram below depicts the characteristics of a call option. It rises as the underlying share price rises, allowing the buyer to enjoy unlimited upside and yet limiting the maximum loss of this investment to the cost or premium paid.

Diagram 1: Buying call options to buy shares

The strategy of buying call options to buy shares gives investors the alternative of participating in the upside of a share price either with or without owning of the underlying share. If the underlying share price rises as expected after the purchase of the call option, the investor has the choice of either selling the call option for profit or exercising the call option to buy up the underlying share, to own it for the privilege of dividend or the advantage of harnessing further gain from the share without the time limit of an option contract.

Bank shares are favourites amongst many investors, especially with the dangling of a juicy dividend. Commonwealth Bank (CBA) will be the next big bank to go ex-dividend in mid-February 2011, with an expected dividend of $1.38 per share, yielding about 2.78% on the current share price of $49.50 (before franking credit).

An investor who on one hand wants to earn the dividend income and the capital appreciation from the share price and yet is still troubled by the slow recovery of the financial sector may not want to put a large chunk of capital at risk.

What if, with the use of options, the investor can spend just a small amount, say $2050 (before costs) to be entitled to the right to buy 1000 CBA shares at $49? Wouldn’t this option free the investor from the potential emotional drain of regretting, if the share price proves to be strong?

The price of $2050 is the premium for one contract of the January 2011 call option on CBA with the strike price of $49 (priced in November when CBA was at $49.50). The purchase of this call option entitles the investor to the right to exercise the contract to buy 1,000 CBA shares if it rises to and beyond $51.05 ($49 strike price plus $2.05 premium paid) anytime up to the January option expiry date of the 27th. The investor who exercises this right on the 27th of January will be in line for the $1.38 coming off (or ex’ed) from the share price in mid-February 2011. If the share price fails to rise as expected, only the small capital of $2,050 (plus cost) is spent.

Diagram 2: Buying CBA Jan2011 $49 call options to buy shares

Without the use of options, the investor could either only stay out and forgo the possibility of income and profit; or jump in but spending (and risking) an immediate $49,500 capital. With options, the investor spends $2,050 to create more opportunities for himself; to either capital gain without owning of shares or owning shares and gaining from income and capital appreciation. The cost of this venture – $2050; potential upside – unlimited. 

Full article with diagram is available on this link.

TraderPlus Dec 2010 magazine

This is a new trading magazine. Subscription is available for free for a limited time.

Options Question: Synthetic Covered Call

Question from reader:
I’ve been reading up all the different types of options strategies, my goodness there’s no shortage and some pretty wild names (iron condor comes to mind). I came across a synthetic covered call strategy. You purchase long dated deep in the money calls rather than the underlying stock as your cover (I guess its like swimming half-naked). The motivation is that the position requires less capital than a traditional covered call. I was wondering your opinion on such a strategy as I’m curious as to how the execution would occur if you assigned for the calls you’ve written, and also how the margin requirements might work (or work against you). I guess you would also need to keep the cash close at hand in case you are assigned, which kind of defeats the purpose of the strategy (in my mind) since the whole idea is to free your money to spread around into other investments (rather than being tied up in the covered position).

You are exactly right about swimming half naked. Unless one owns the underlying share, one can never be guaranteed of full cover, due to the following reasons:

1. Dividends. One can be out-of-pocket with the dividend amount and it can be very painful especially over a high dividend paying stock like the banks. eg. a $1 dividend payout per share translates to a loss of $1000 per contract.

In this trade, the trader who opened the position is not entitled to receive any dividend (from the bought call) but is obligated to deliver stock cum-dividend (from the short call) if assigned on the last day of cum-dividend.

2. Another problem with this strategy is the delivery of franking credit attached to the cum-dividend stock, not only that the trader need to pay out -of -pocket the dividend amount, but the franking credit attached to it as well. Even if the trader can recover the dividend, franking credit is never priced in in options pricing. Its an additional out-of -pocket amount. This risk can never be covered by an option position (no matter how deep In the money the call option is), it can only be eliminated by the holding of the underlying share.

3. Corporate actions can throw this strategy off. Eg an underlying share announces an off market buy back during the term of this strategy. Often a large component of the buy back consists of franking credit in addition to a smaller capital component. The trader could be caught assigned (via the short call) to deliver shares cum-entitlement on the last day, and to make matter worse this pain can be prolonged as the trader may not find out the exact amount of this “pain” is (the franking credit component) until 45 days after shares have gone ex-entitlement.

This list is not exhaustive. In short, they sound good in theory, but in practice, it’s riddled with problems. The trader in this strategy is still swimming partially naked. (Read my article on Swimming Naked in YTE Magazine Sep/Oct 2010 Issue, posted on 1 Oct 2010)

Traders who choose to undertake this strategy need to be aware that actual losses incurred in this trade can be more than the spread. It’s not for a portfolio investor. Only the aggressive should venture.