Options for Success
YTE Magazine Mar/Apr 2011
Investing successfully with options can become a reality for you, says Wai-Yee Chen.
Most people regard options as an aggressive trading tool. Some people even imagine that options traders sit at their desks pressing buy/sell buttons in a manic fashion during trading hours. Some are thought to have ‘made it’, while others lose more than they can afford.
That may be the image of an options trader, but is it the reality?
Consider the following choice of methods for purchasing a product you want – say the latest widescreen LED television. You could:
• Spend your own money to buy what you want (e.g. using EFTPOS or debit cards)
• Spend other people’s money first and have the enjoyment of the product now (e.g. using credit cards or loans)
• Spend a fraction of your money now for the right to buy later, if you choose to (e.g. a rent-and-buy scheme).
Those who hold traditional values may prefer the first method. Then there is another group of people, willing to pay more for the use of other people’s money. The third group may choose to give themselves more time to consider their purchase and spend a smaller amount now for similar enjoyment of the product.
There is a fourth method, where you can:
• Delay spending what you have and yet earn some money now, in compensation for the possibility of not being able to buy what you want. For this group, having the income now is as good as enjoying the product now.
I struggle to think of a merchant who offers this deal to consumers. However, there is a ‘market’ that offers you this method of buying. It lies in the purchase of shares. Investors who believe in the traditional values of using their own money and yet who are willing to chance owning a particular share, can benefit from this method of buying shares. There is no manic trading, and with correct money management, no losses larger than you have committed to spending to buy the shares you want.
This method is the selling or writing of put options to buy shares.
Let’s follow the journey of John, who would like to purchase 1000 shares in Wesfarmers Limited (WES.ASX), a diversified conglomerate listed on the Australian Stock Exchange. WES shares are trading currently at $32 per share.
From the four purchase methods mentioned previously outlined, the table shows the choices available to John for the buying of 1000 WES shares.
1.Per share or per option contract. Prices of options (premiums) are for February 2011 expiry term for the strike price of $32.
2.Assumed a 70% gearing ratio.
3.Each option contract represents 1000 underlying share exposure. Each strategy is for one option contract.
4.$32 strike price – $1.00 premium received = $31 for 1000 shares
5.If share price falls, but up to a maximum of $32,000 where gearing is at 0%.
6.Margins can be funded by shares (margins increase as share price falls but estimated to be 10% of total exposure at the start).
7.Sellers of put options have the chance to buy the shares only if the counterparty chooses to exercise the contract to sell his/her shares.
In choosing the fourth method, John is not exposed to any more than the $32,000 a traditional investor would spend using the first method. Not only that, but he is getting paid ($1000) and may spend less on a future purchase ($31,000). Why aren’t there more investors using this method?
The biggest issue is the receipt of cash, which is a double-edged sword. While it’s positive, and good cash-flow management, it’s also a big temptation. Being paid by selling options is like being paid to take home a TV. Obviously, the more contracts you sell (or the more TVs you buy), the more cash you will take home. Does that make sense though? How many TVs can one have in one’s home, before something or someone explodes?
The next issue is that some investors have a fear of the unknown. They may hold the premise that ‘the risk you know is better than the one you don’t know’. While these fears are real and can be sometimes useful, they can be overcome quickly by reading and learning, through books and seminars. New, positive experiences can replace these fears.
Our brains are like very sophisticated, powerful computer systems. We can re-write our memory. By pressing the ‘save’ button after a positive experience, previous negative experiences can be over-written. As we build in more and more positive experiences, more and more negative ones are replaced. There then emerges a new image of an options investor – one who is a disciplined, smart money manager with traditional values.
Creating such an image and investing successfully with options can become a reality for you.
Wai-Yee Chen is the author of ‘OptionsWise: How to invest sensibly’. Wai-Yee regularly conducts seminars and shares her ideas about options on CNBC and Sky Business Channel. Her latest options strategies, information on her up-coming seminars and a copy of her book can be found and purchased at http://www.optionswise.wordpress.com.