Option Basics

[Magdoran]

thanks for clarifying that Margeret.

Ive used 3 different brokers and in each case Ive never had to say squat about exercising, which we can assume means its automatic for them. I know there are some brokers who dont charge $4k in brokerage for buying & selling $300k worth of FPOs but its rare. Its this huge cost that I based my argument on, so it really does depend on which broker you use. This cost can be a huge surprise and is an important point. I also didnt realise it was hypothetical mechanics rather than practical. My bad.

As for ASX articles, they have a funny habit of "inventing" very similar strategies after I publish mine......

Hello money tree,

Actually, that’s a very good point about situations with large parcels of shares, where some brokers charge heavily above a certain value like 1% or above on a 300k position.

In this case I can see the effectiveness of buying an ITM front month call and exercising it if it works out to be cheaper. Depends a lot on your broker and position size.

I can imagine a 15 contract position for a $20 odd dollar stock being a killer to deal with if your broker is going to charge a percentage. Not a good way to trade, $4 K is way too much brokerage in my view. Personally I’d either do a deal with the broker, or fire them. It’s so competitive now, and if they want your business, they’re going to have to play ball.

Speaking more broadly about personal preferences, I tend to wind out single series bought options preferably before 30 days till expiry to avoid the theta decay, and only hang in if the move looks like it is strong once the OTM option had moved ITM… but that’s a personal preference, isn't it?


Regards


Magdoran

 

[shares]

hi everyone

I purchased some Lincoln Mineral Shares a couple of weeks ago and after taking a look at the prospectus I found this:

At this stage, an issue of 1 free Option for
every 2 Shares held by Shareholders on the
register is intended to be made some three
months after Listing on ASX. The Options
will be exercisable at 30 cents each and will
expire 3 years from the date of issue.

I bought 10,000 shares and Lincoln opened on the stock market on the 9th of March.

Does this mean that on the 9th of June (3 months after opening) I will receive an additional 5,000 shares which I will be able to sell at any price over 30 cents?

 

[Glenhaven]

hi everyone

I purchased some Lincoln Mineral Shares a couple of weeks ago and after taking a look at the prospectus I found this:

At this stage, an issue of 1 free Option for
every 2 Shares held by Shareholders on the
register is intended to be made some three
months after Listing on ASX. The Options
will be exercisable at 30 cents each and will
expire 3 years from the date of issue.

I bought 10,000 shares and Lincoln opened on the stock market on the 9th of March.

Does this mean that on the 9th of June (3 months after opening) I will receive an additional 5,000 shares which I will be able to sell at any price over 30 cents?

Sorry I don't know the answer, however, I have been trying to find out. I could not find a website for them or any information in the news items. I would normally look in the propectus for clarification, but you have already done that.

 

[shares]

Thanks for having a look GlenHaven I really appreciate it.

 

[bvbfan]

The offer is this...

Within 3 months of listing (so by June 9) shareholders who are registered as such on the books of Lincoln Minerals at a given day in that 3 month period will be eligible to received the 1 for 2 option offer.
That means you would received 5000 options for no cost.

The option allows you to buy another 5000 LML shares at 30c between being issued the options and the expiry date of the options.
If they list the options on the ASX you can choose to sell the options also, and generally they would have some value above the difference between LML shares and the 30c to be paid (time value for the option)

 

[Glenhaven]

The offer is this...

Within 3 months of listing (so by June 9) shareholders who are registered as such on the books of Lincoln Minerals at a given day in that 3 month period will be eligible to received the 1 for 2 option offer.
That means you would received 5000 options for no cost.

The option allows you to buy another 5000 LML shares at 30c between being issued the options and the expiry date of the options.
If they list the options on the ASX you can choose to sell the options also, and generally they would have some value above the difference between LML shares and the 30c to be paid (time value for the option)

Does anything define "at a given day". The question is that day in the past or yet to be announced. The issue being what you sell or buy now.

 

[bvbfan]

They will announce the day in advance, so people who want it can get in, this should push LML share price up. If the other stocks that have done this are any guide.

 

[Glenhaven]

That's why I was interested. If this is true one should buy now. It does seem odd though that they are to give something away. Reminds of the old bonus issues which never happen now.

 

[bvbfan]

They are asking people to keep money locked into the share, which after the shares goes ex entitlement will drop quite a bit usually so it's a bit of a sweetener to keep holders interested

 

[shares]

thanks for the info

They will announce the day in advance, so people who want it can get in, this should push LML share price up. If the other stocks that have done this are any guide.

hopefully it does go up lots and lots

 

[Glenhaven]

Must say I am still not 100% convinced. Companies do offer loyalty issues, like Telstra where you get a bonus 4% in shares if you hold the installment receipts until the second payment. However, this is only for those that bought in the issue and do not sell, if you purchase the IR's on market you do not get the bonus.

I would understand it if this was the case with Lincoln Minerals, however, you are suggesting that there will be a free options issue to whoever holds the shares at a date to be announced. I would like something that confirms this. Do you have a source. The words in the propectus do not say that a purchaser of the shares on market will get them.

 

[potato]

Hey everyone, I just wanted to know which options are the best to trade in terms of liquidity (ASX stocks) what sort of levels of open interest should you be looking for? any examples would be appreciated. Also what else is popular to trade options with besides stocks here in australia?

 

[Higgshr]

Re: Option Basics - ASX XJO Adventures

ASX XJO Adventures

I have been doing a basic Covered/Buy Write strategy over the last 10 months, and it has done quite well. Now with some market volatility I thought it best to start some "hedging".

My first question to the forum is about ASX XJP Put Options.
ASX articles - Portfolio protection with index puts

My query is regarding the Max. Loss of portfolio. Little unsure how this works, as this would time decay and set by the market, so I am not sure how you can so this is the max protection.

My understanding is to cash out, you would have to sell out at that point, or await to expiry date. This is a bit fuzzy??? Any first hand experience or views on this, or even other approaches?

 

[It's Snake Pliskin]

What determines the premium in a covered call?

eg; 5,000 x $0.38 = $1,900

Where does the $0.38 come from?

5000 shares purchased at $9.00 and the price is now $13.07.
Will sell at $14.00.
The premium is $0.38. How is this calculated?

 

[wayneL]

What determines the premium in a covered call?

eg; 5,000 x $0.38 = $1,900

Where does the $0.38 come from?

5000 shares purchased at $9.00 and the price is now $13.07.
Will sell at $14.00.
The premium is $0.38. How is this calculated?

Snake,

When you sell a $14 call option over those shares, you are obliged to sell your shares to the call buyer for $14, if he calls your shares.

Obviously, he will only do that if the shares are trading for greater than $14 at option expiry. Your share could be trading at $18 as an example, so in this case you have lost $3.42 in opportunity cost.

You want to be paid for this risk, that is what the call premium is.

The amount you get paid for taking this risk will depend on the markets perception of this risk of the call expiring in the money (> $14)

* The closer the current price is to $14, the greater the risk of it expiring at > $14, the higher the call price.

* The greater time till expiry, the greater the risk of it expiring at > $14, the higher the call price. (also the greater your carrying costs are)

* The more volatile the share, the greater the risk of it expiring at > $14, the higher the call price.

This is all calculated via an option pricing model (Cox, Ross & Rubinstein for American style options usually) of which the inputs are:

Current share price
Strike price
Time till expiry
Risk free interest rates
Dividends
Volatility

... to give the theoretical option price.

As the volatility input is an estimate of future volatility, the option price may vary from *your* theoretical price and it is ultimately governed by price discovery via the bid and ask. The price will therefore generally be the result of the consensus of forward volatility by the marketplace as a whole. (Or in the absence of actual traders the market makers).

 

[It's Snake Pliskin]

Snake,

When you sell a $14 call option over those shares, you are obliged to sell your shares to the call buyer for $14, if he calls your shares.

Obviously, he will only do that if the shares are trading for greater than $14 at option expiry. Your share could be trading at $18 as an example, so in this case you have lost $3.42 in opportunity cost.

You want to be paid for this risk, that is what the call premium is.

The amount you get paid for taking this risk will depend on the markets perception of this risk of the call expiring in the money (> $14)

* The closer the current price is to $14, the greater the risk of it expiring at > $14, the higher the call price.

* The greater time till expiry, the greater the risk of it expiring at > $14, the higher the call price. (also the greater your carrying costs are)

* The more volatile the share, the greater the risk of it expiring at > $14, the higher the call price.

This is all calculated via an option pricing model (Cox, Ross & Rubinstein for American style options usually) of which the inputs are:

Current share price
Strike price
Time till expiry
Risk free interest rates
Dividends
Volatility

... to give the theoretical option price.

As the volatility input is an estimate of future volatility, the option price may vary from *your* theoretical price and it is ultimately governed by price discovery via the bid and ask. The price will therefore generally be the result of the consensus of forward volatility by the marketplace as a whole. (Or in the absence of actual traders the market makers).

Hi Wayne,

Thanks for the detailed reply.
So the risk premium is a combination of this:
Current share price
Strike price
Time till expiry
Risk free interest rates
Dividends
Volatility

Have I understood this?

 

[markrmau]

* The closer the current price is to $14, the greater the risk of it expiring at > $14, the higher the call price.

* The greater time till expiry, the greater the risk of it expiring at > $14, the higher the call price. (also the greater your carrying costs are)

* The more volatile the share, the greater the risk of it expiring at > $14, the higher the call price.

Pls replace "higher the call price" with "higher the premium"

 

[wayneL]

Hi Wayne,

Thanks for the detailed reply.
So the risk premium is a combination of this:
Current share price
Strike price
Time till expiry
Risk free interest rates
Dividends
Volatility

Have I understood this?

yes

 

[wayneL]

Pls replace "higher the call price" with "higher the premium"

For clarification.

The option price can be described as extrinsic plus intrinsic value. ( in this case intrinsic value is zero )

The option premium can be described as extrinsic value only.

In this specific example, premium is the same as price. But where an option is In The Money, price will be different to premium as there will be intrinsic vale included.

 

[Magdoran]

Hi Wayne,

Thanks for the detailed reply.
So the risk premium is a combination of this:
Current share price
Strike price
Time till expiry
Risk free interest rates
Dividends
Volatility

Have I understood this?

Hello Snake,


Yes, you’ve got it pretty much right in a nutshell, however, here’s something to think about which might add to Wayne’s excellent answer.

While this subject has been covered elsewhere in the derivative area, essentially the option price is the premium a seller of the option requires like the premium you pay to an insurance company. Think of it like that and the values will start to make sense.

Essentially writing (selling) options can be seen as issuing an insurance policy to the other party, or perhaps a bet that the option will go down in price and can either be left to expire worthless or bought back at a cheaper rate later. Hence the premium (price) demanded is in part a market driven value (included market maker tactics and involvement, especially in less liquid a markets) and in part a theoretical value.

Option pricing is an involved process since you are dealing with a range of concepts simultaneously in order to arrive at a theoretical valuation on one level as you know, and an actual market price on another.

Various pricing models have been developed in an attempt to establish relatively objective methods of valuing an option at a particular price over an underlying financial instrument at a particular time.

The two dominant mathematical models which have pages of formulas involved are “Black and Scholes” and “Binomial” (I prefer Binomial since it tends to be more robust in my view).

The key attributes of each option makes it unique in the way it will perform given movement in time and price.

Hence inputs into the model as you have identified are time to expiry, strike (or exercise) price, value of the underlying the option is over, dividends, and the interest rate component. In addition this gets complicated because of “volatility” which encompasses the inflation of the theoretical flat price since the effects of supply and demand inflate the option value, and volatility measures this level (this has been covered in detail on many of the derivative threads).

All these inputs result in a theoretical value, and then the market conditions alter this as an expression of volatility. Hence the price is the base value inflated by the odds the selling side are giving, very much like the way a bookmaker discounts some contenders in a horse race which are unlikely to win, while increasing the cost on others they consider more likely to win, or sometimes in order to hedge their book.

So, in your example, if the option was an out of the money call with 2 months to expiry, with a volatility of “X”, and a specific interest rate, and the underlying was trading at “Y”, you’d arrive at a theoretical value. Then the fun begins since there will probably be a spread between the bid and the ask, which will be jumping around as the underlying trades – each with its own fluctuating value and volatility measure.

Since no one has a crystal ball, the valuation is based on what the market thinks is likely to happen which is where the shadow falls between the theory and the practice.


Hope that helps!


Regards


Magdoran