How to invest in derivatives
Smart Investor Magazine
PRINT EDITION: 18 Feb 2011
UPDATED: 13 days ago
PRINT EDITION: 18 Feb 2011
UPDATED: 13 days ago
Monday 25 July 2011 10.10am
Reporting on Australian Options Actions week ended 22 Jul 2011
1. Stockland SGP.ASX (Last $3.14)
One that is not often featured in high volumes, but higher than usual options volume had been going through Stockland in the last 2 weeks. Two weeks ago dominance was on the put side, with about 20% more puts than calls traded. Last week Tuesday (19 Jul), as SGP touched an all time low of $3.08, there was a switch. Last Friday, we can see more confidence on the long side in the share. There was a large trade with 5000 contracts of buying of calls, the series attracted the buying was the Aug $3.10 call. On the puts, though with smaller quantities, selling of the Aug $3.00 put was seen. These strategies seem to be trying to go long on the stock which has returned to a 2 year low. It was last at this level in Aug 2009.
My preferred strategy for SGP though would be the selling of the Nov11 $3.10 put for about 11.5c (theoretical). If sellers are “put” stock in November, sellers of put would buy up SGP below $3.00 and get entitled to estimated dividend of 11.8c per share (4%) before Christmas (with pay day in February 2012). No need to buy the stock outright just yet.
2. Fortescue Metals Group FMG.ASX (last $6.64)
FMG had a good week outperforming the broader market and its peers BHP andRIO. Is it likely to experience a continued strong trend?
18 Jul to 22 Jul 2011
We had active trading on both the calls and puts on FMG last week with steady volume, matching that of the week before. As FMG rose 3.75% last week, some protective strategies have set in. On Friday, there were large volume in selling of Aug $6.75 calls with the largest open interest for calls positioned at the $7.00 call level with some buying of Jul $6.50 put as well.
As FMG ascended last few weeks, in an orderly and slow manner, without an increase in volatility, it does not look like it will breach above $7.00 strongly nor fall much off the $6.50 level as we move towards expiry this Thursday.
3. Bluescope Steel BSL.ASX (last $1.29)
Since 4 weeks ago (27 Jun) when BSL was sold to a low of $1.115, except for just 1 out of the 20 days, calls had been more active than puts. Last Friday, calls were again more actively traded, there were about 43% more calls traded than puts and Friday’s calls made up 37% of the calls traded for the week.
An active series was the buying of Aug $1.20 calls.
With the positive put/call ratio on the stock, there may be more bullish moves ahead.
Tue 19 Jul 11 | 11:10 PM ET / 1.10pm Australian EST
CNBC interview with Oriel Morrison
Monday 18 July 2011 10.10am
Reporting on Australian Options Actions week ended 15 Jul 2011
1. NCM.ASX (last $40.27)
Gold has been a stalwart in the last 3 weeks. Whilst the S&P/ASX 200 has basically done a boomerang in the last three weeks (started and finished around the 4470 level), NCM has climbed 10.4%; outperforming not just the Australian market but also the US dollar Spot Gold price by 4.5% (which closed at USD1592.99 on Friday). After such a strong 3 week performance and NCM at early $40, what are options traders’ thinking?
Firstly, volume in NCM options have increased in the last two weeks and domination has switched from puts to calls in the last 2 weeks. Especially on Friday last week, some large quantities of bear strategies have been observed.
On the put side, large quantities of buying were seen going through the Jul $3950 put which appears to be part of a bear put spread strategy which was accompanied by the selling of the Jul $3800 put.
Whilst on the call side, large quantities of the Jul $4100 calls were traded, which were accompanied by some bear call spread strategy as well. The July and September calls were popular.
In summary, having risen 10% in just 3 weeks and sitting above $40 last week and with higher implied volatility on the stock, some bear spread strategies which involve the selling of options to capture the higher premiums have set in. These strategies may be a precursor to the stock turning down.
2. BHP (last $42.89)
Following BHP’s announcement of its acquisition of US’ shale gas operator Petrohawk for US $15.1b on Friday, BHP‘s share price has reacted with a fall of 71c of 1.63% on its share price, whilst its peer RIO rose 0.5% instead. The view is mixed. Based on RBS Morgans’ preliminary modelling of the assets, the deal is 1% EPS accretive in the first year, and 1% NPV dilutive. The key risk is oversupply in the US market, which may suppress prices for an extended period. Long term though, if export capacity can be opened up, this may lead to a greater level of pricing tension (some way off). While the deal helps BHP gets a foot in to the US gas market but the acquisition reduces the chance of a buyback being announced in its August results as well, which was a catalyst for the stock.
How did options traders react to the deal?
Options volume on Friday, doubled that of last Thursday and Wednesday but there has been no change to the trend of the stock though. Trading is more active on the put side. The put/call ratio for BHP sits more on the bearish side with an average of 1.3 times for the week.
The larger trades seem to be a combinations of bearish strategies.
On the call side, selling of Jul $4450 call was popular and some were accompanied by buying of lower call strikes as a bearish strategy.
Puts were active and the larger trades were the selling of Jul and Aug $4300 puts which were combined with higher strike puts like $4400 to create bear put spreads.
Overall, the balance seems to be on the bearish side on BHP.
3. RIO.ASX (Last $81.36)
Despite the more positive trading session on Friday versus BHP, from options perspective, the actions are quite similar. Put/call ratio is negative on RIO with an average of about 1.4 on a weekly basis in fact, Friday’s put/call ratio was at 1.78, worse than the weekly average.
Some of the trades observed were the selling of Jul $7200 and $7900 puts which were combined by buying of higher strike puts like the $8000 or $8200.
At the call end, selling of Jul and August $8200 calls were observed.
As Friday’s move up (on RIO) was not accompanied by higher volumes, the weak trend experienced in BHP and RIO, may continue until turn arounds are signalled.
Identifying an ongoing range can still generate returns by the use of the strangle strategy. By OptionsWise author Wai-Yee Chen
I emailed a client recently to take a sizeable profit just one week after opening a covered call position. He said, “It’s been so hard making any capital gains anywhere, it’s a relief to earn some income from my shares. Get me whatever you can.” Sounds desperate? Maybe. But if this is how you had been feeling lately, you are not alone.
The culmination of a high Aussie dollar, softer commodity prices after a string of natural disasters across nations have caused the Australian share market to do a one step forward two steps backward“dance” in a 4700 to 4900 range in the past four months since January.
Some shares had been trading in a range, too. Woolworths announced a good profit result and ran towards $27.50, but has since cooled off to about $26.50. Commonwealth Bank raced up to $54 pre-dividend and retraced to $50. CSL fell from $37 to $33 reeling from a strong Aussie dollar.
Some may like to hold on to their shares instead of trading these ranges. With this strategy though, there will be no other returns beyond dividends (if any). For investors who want to hold on to their shares – not trade the small ranges – and yet want an extra income stream, options will be your aid.
The options strategy useful for a range trading share is the selling of strangle strategy. Options are used to replicate a share’s trading range by the selling of options at the two pressure points (lower and upper ranges) to squeeze income out of the share.
Let’s look at the example of Commonwealth Bank.
CBA is trading right in the middle of its range at about $52. There will be no dividend payment for another four months.
The investor may well be carried between the $50 and $54 range in the next few months with no income within the period. With the use of the sell strangle strategy; the investor has the potential to get more from his shares.
Here is the sell strangle strategy on CBA.
Starting from the lower range of $50, the investor sells a $50 put option and for the higher range, sells call options at $54.
In terms of timeframe, the investor decides to execute the above strangle for two-months. Though a longer term can generate higher premiums, as time adds more value to option pricing but being too close to the ex-date in four months risk the shares being assigned or called away prior to ex-dividend.
Selling of the two-month $50 put and $54 call gives the investor a total of 80 cents for every share owned.
You may be saying, “That’s great, an extra 80 cents of income from the shares, but what is my downside risk?”
The downside risk for a sell strangle strategy is when the share fails to adhere to the expected range and breaks out, either on the up or down side of the range. Selling of call options poses the potential of selling shares and selling of put options renders the potential of buying more shares. These two possibilities or risks are the compromise for the income of 80 cents per share.
If the share breaks above its upper range, then the investor loses out on the opportunity of maximising the potential gain from the share. If it breaks support and falls to a next lower level, then the investor may be up to buy more shares. To manage these two potential risks, these options (selling of put and call) can be closed out (by buying back) when the share trades at either of the breakeven prices; of $50 – 80c = $49.20 (on sold put) or $54 + 80c = $54.80 (on sold call).
Identifying a determinable range is the prerequisite of the sell strangle strategy. If the range fails to eventuate, be willing to buy more at $49.20 and sell shares owned at $54.80.
The sell strangle options strategy gives you whatever you can get from your shares.
Monday 11 July 2011 10.10am
Reporting on Australian Options Actions week ended 8 Jul 2011
1. BSL.ASX (last $1.35)
Definitely one affected by the carbon tax debate/debacle, whichever way you choose to see it.
These options actions are observed Thursday, Friday past, a couple of trading days before C-Day on Sunday. Whether these trades prove to be “smart” money or not, we will know on Monday (11 Jul).
These are what’s been observed.
There were visibly more puts traded on BSL Thursday and Friday, with a switch from the calls side on Wednesday. These volumes on puts seem to be for buying as well. Especially on Thursday, there was a buying of 20,000 contracts of puts in 1 trade. The put interest was for the July $1.20. which is also the one with the largest Open Interests in all BSL puts.
In addition, selling of calls has set in as well at the $1.50 level. One that attracted attention on Friday was the Aug $1.50 call. Most opened calls are positioned at the Jul $1.50, followed by $1.40’s.
In brief, there is some nervousness for BSL at the $1.50 level and some have taken protection, in case the news on Sunday negatively impacts the stock, and renders it falling all the way back to $1.20.
2. IPL (last $4.01)
IPL is NOT one often featured in the options space, but stood out last week.
On Friday, as the stock was about to breach above the $4 level, there was a large buying of calls when the share was trading around $3.98. It was the Jul $4.00 call which was in demand and traded for about 9c. As this option is now in-the-money (with IPL closing at $4.01) any cent above the breakeven price ($4.09) will be a cent for cent profit for the buyer until 28 Jul expiry (19 days away).
WHAT’S UP WITH IPL?
1 Technical analysis calls it a Buy with a break above $3.97 (the move above could be technically motivated)
2 IPL provides exposure to both the rising soft commodity markets and leverage to an economic recovery in North America. In addition, IPL’s earnings tend to be skewed towards its 2nd half. With Fertiliser, 70% of its earnings comes in 2nd half as fertilisers are applied on cereal crops and cotton throughout the winter months in Australia. For Explosives, 2nd half tends to be bigger earnings period as well as construction (in quarry etc) increases in summer months in North America.
Though there was a contrarian trade in the market as well, with some large volume of selling of Sep call at $4.00 went through at 24.5c per contract last Thursday, but overall the weight of trade is on the call side, especially on Friday, there were 3 times more calls traded.
3. FGL.ASX (Last $5.13)
Takeover play in FGL has cooled off last week especially with FGL rejecting SAB Miller’s $9.98 billion deal and also as SAB Miller said on Wednesday (6 Jul) it will be looking at acquisitions at Brazil too.
Buying of puts has set in on FGL.
The popular series were the Aug $5.05 put and Sep $5.05 puts. Selling of call options had been observed as well at the Jul $5.05 call level.
According to options action, it’s time to lock it in.
Betting on Telstra
Wai-Yee Chen Head of Derivatives with RBS Morgans chats to Oriel Morrison of CNBC her views on Telstra as an asset.
With lingering hesitation in the market to increase risk appetite and issues yet to be ironed out (sovereign debt, Chinese growth, reporting season), a stable good paying stock like Telstra may just be the right remedy for investors who are as hesitant as the market.
In addition, TLS has lost 4% post announcement of its deal with NBN co and government, providing some downside buffer for those who are interested to buy the share at this level.
WHAT’S UP WITH TLS?
TLS will be reporting on 11 August, most likely with a flattish report card. With that in mind, the stock is likely to hover around its current level of $2.95 with a possible 5c plus or minus range till about 25 August (the expiry date of August options).
In the current market environment, cash in the pocket is much more desired than paper gains (or losses) sitting in portfolios.
Our goal with TLS is to make the share sitting in many Australians’ portfolios, work harder; even for those who don’t own the stock, the opportunity to buy the stock and implement the strategy below for more cash in the pocket.
Existing shareholders or those who will be buying it will be entitled to the 14c dividend which is expected to be ex’d around 23 August, generating a yield of 4.7% on $2.95 in less than 50 days.
But, with the use of options, we can do better.
Options Strategy on Telstra
With the view that TLS will not move much away from its current price of $2.95, we will use options to create a range for the share, but at the same time giving it a wider room to run within it, catering for the impending sluggishness in the stock after it sheds its dividend.
Strategy in detail:
Leg 1 # sell call options
Sell Aug $3.10 call for 2c credit per contract (100 shares)
Leg # 2 sell put options
Sell Aug $2.80 put for 5.5c credit per contract (100 shares)
The total income from these two trades are a combination of 7.5c, raking in an extra 2.5% yield on top of the 4.7%. A total of 7.2% in less than 50 days.
TLS stays within $.280 to $3.10:
Shareholders of TLS will enjoy the 7.2% yield if TLS trades within the $2.80 to $3.10 range by 25 August.
TLS below $2.80:
What if Telstra falls more than its dividend of 14c from $2.95 to below $2.80?
Then, the investor will be assigned to buy more TLS shares at the breakeven price of $2.725 ($2.80 put strike – 7.5c options income earned).
The new shares purchased via options assignment will most likely not be entitled to the 14c dividend, but existing holdings (either already owned or purchased for this strategy) would.
TLS above $3.10:
The other possible scenario is TLS running up strongly before its expected ex dividend date of 23 August and breaches the $3.10 level.
Then, the investor may be assigned to sell their current holdings at $3.175. Assuming purchased at the current price of $2.95, that is a return of 22.5c or 7.6% in less than 50 days.
Either way, looks like your pocket will be at least 21.5c heavier (for every 100 shares owned).