There are two types of Options traded on the ASX: Call and Put Options. Volatility, interest rates and time to expiry all effect the Option price.
Call Options
Call Options give the buyer (taker) the right, but not the obligation, to buy the underlying shares at a predetermined price on or before a predetermined date.
Put Options
Put Options give the buyer (taker) the right, but not the obligation, to sell the underlying shares at a predetermined price on or before a predetermined date. The taker of the put is only required to deliver the underlying shares if they exercise the option.
In order to take up the right either to buy or sell the underlying shares, the taker must exercise the Option on or before the expiry date of the Option contract.
It is important to note that the taker of the Option is not obligated to exercise the Option. The taker can sell the Option, thus closing their position. Alternatively they can let the contract lapse and close worthless.
Put Option Example
XYZ share at $10.00 (eg: September) gives the taker the right but not the obligation to sell 1,000 XYZ shares for $10.00 per share at anytime until the put option expiry date. For this right the taker pays a premium (or purchase price) to write the put option. In order to take up this right to sell the XYZ shares a specific price the taker must exercise the option on or before the expiry day on the given month (eg: September).
Once again it is important to note that the taker is not obligated to exercise the option
Call Option Example
XYZ shares with a last sale price of around $10.00, an available standard call option contract would be XYZ October $10.00. A taker of this contract has the right but not the obligation to buy a thousand XYZ shares for $10.00 per share at the time until the expiry day in October. *
- For this right, the taker pays a premium (purchase price) to the writer of the option. In order to take up this right to buy the XYZ shares at the specific price the taker must exercise the option on or before the expiry date. *
- The expiry date is usually the last Thursday before the last Friday in the expiry month unless the options clearing house (OCH) determines another day.
Risks in trading Options
There are 3 major risks associated with trading Options:
- The Option Price Decreases With Time: Time decay is an important factor as it works against the taker of an Option as the value of the option price decays with time. Time decay increases at a greater rate as the expiry date draws closer. As time passes, the opportunities for an Option to become profitable decreases. Therefore as the taker of an Option, an investor needs the share price to move far enough in their favour to outweigh this loss of time value. The option expires worthless at the end of the option contract if it is "out of the money".
- Other factors that may influence the Option price: Volatility, interest rates and time to expiry all effect the Option price.
- Because of it's leverage component, investors may suffer large losses: Leverage facilitates greater gain for less outlay than purchasing the underlying shares. However potentially greater losses may be incurred if the underlying shares do not perform as anticipated.
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