Options are appealing to traders because of their versatility, flexibility, and profit potential. They represent a form of derivative trading that allows individuals to engage in transactions involving securities within the Australian stock market.
Given the market's volatility, options trading has emerged as a favoured alternative strategy for managing risk, safeguarding existing share portfolios from potential declines, and capitalizing on periods of low capital growth to generate income.
In this blog, you will learn the fundamentals of options trading in Australia, the pros and cons, the best options trading platform, how to trade and buy options, options brokers, and the steps to follow to get started for beginners.
1. What Are Options?
Options, also known as Exchange Traded Options, are derivative financial instruments with no intrinsic value. These contracts derive their value from their underlying stock.
As flexible tools, Options enable traders to enhance their existing strategies and forecast future financial market prices. Unlike tangible assets, these contracts allow investors to transact (buy or sell) before expiration, generating profits.
The regulatory authority overseeing options and binary options in Australia is the Australian Securities and Investments Commission.
2. What Is Options Trading?
Options trading involves the buying and selling of options on the market. These financial contracts give investors the right to trade an underlying asset at a predetermined price, but only if the asset's value exceeds that price within a specified period.
The price you pay to purchase the option is called the 'premium'.
3. What Can You Trade With Options?
4. Why Is Option Trading Popular Among Investors?
Trading options are promising, especially when the market is flat and bearish. With it, you can limit your risk exposure and protect the value of your existing share portfolio in the falling market.
Although many consider it risky and more complex than standard stock trading, it can protect your stock investment value against losses and increase profits. The trader's potential loss from an Options trading strategy is limited to the premium paid.
5. How Does Options Trading Work?
Investors can trade options in the following ways:
6. Advantages Of Options Trading
The best benefit of trading in options is the upside potential, with losses limited only to the option's premium.
They are helpful as a source of risk hedging and leverage.
Short-term options trading can also help you earn some additional money by investing. A covered call can help you generate income immediately in a sideways market.
Is it profitable to trade options? Yes. You can make higher returns than directly investing in stocks with a smaller initial outlay.
Options trading strategy allows you to benefit from fluctuations in a share price without needing to pay the share price.
Unlike paying the price of shares, Options trading enables investors to diversify their portfolio with a smaller initial outlay.
The Call Options give you time to decide on purchasing shares. By paying a fraction of the shares in the form of a premium, you can lock in the buying price, and you can buy those shares any time before the expiry date of your option.
Options trading enables you to implement an array of option trading strategies in several market conditions (falling, rising, or flat). You can choose the one that best suits your needs.
7. Is Options Trading Better Than Buying Stocks?
The primary disadvantage of options trading is that if the stock price remains unchanged according to your estimates within the specified period, you will lose the entire premium you paid.
However, this is not the case with "direct investment in stocks" because the share price can come to your estimated price after some time (after the options expiry).
Can Amplify Your Losses
Leverage can get you higher profits in options trading but can also result in higher losses if the stock price doesn't go in your favour until your options expire.
Though Options trading may be more affordable than regular stock trading, it is more time-bound. Only experienced investors who are 110% sure that the stock price will reach its price target at a set duration should invest in Options Trading.
Option writers (who sell Options) may face unlimited losses when the contract they sell moves against their speculations. This way, they would lose more than any premium received.
Prone To Market Risks
Traders must be aware of the stock market's unpredictable nature, which is influenced by various socio-economic factors.
A "time-bound" options trading may fail due to unforeseen circumstances, but if you are a long-term player in the stock market, you will eventually win the race.
Can't Participate In Corporate Action
Both the Call option taker and the Call Option Writer are not eligible to receive dividends and participate in voting on the underlying shares until they transfer the shares.
Options Trading is more complex to understand and execute than regular stock trading.
It is for experienced investors and risk-takers who understand in which direction the stock price will move in the near term.
However, if you are a beginner trader, risk-averse, willing to hold stocks for the long term, and want decent returns from the market, then stock trading is the ideal route for you. Beginners should trade under the guidance of an experienced Options trader.
8. Components of Option Trading
The five components of an option contract:
9. Steps To Trade Options in Australia For Beginners
Follow the below steps to learn and start options trading in Australia:
Step 1: Open An Options Trading Account
Compare different options trading brokers on a range of factors, such as:
ASIC Regulated or not
Types of markets served
Convenience, Ease of Navigation, etc.
Availability of research, trading, and learning tools
Step 2: Understand Options Trading Terminology
Before you start trading in Options, you must be familiar with specific Options trading terminology that includes:
Holders and writers
In the money
Out of the money
At the money
Step 3: Choose An Options Trading Strategy
There are various options trading strategies available to get different results when trading options. Some of the popular ones include:
Buying a call option
Buying a put option
Hedging your investment
Short calls (selling a call)
Step 4: Choose A Market To Trade Options On
Many brokerage firms in Australia let you trade options in Australian stocks and other markets such as EUR, USD, GBP, CHF, etc. Identify which market you want to trade in and learn how those markets perform.
Step 5: Fund Your Account
Before you start trading options, you need to have adequate money in your brokerage account. If you plan to use leverage, you will need sufficient funds to cover potential losses.
Step 6: Research
Extensive research is needed to develop effective trading strategies to realize desired profits.
For this, you need to determine the period during which the market is probable to move.
Based on the type of trade you plan to make, you can opt for daily, weekly, monthly, or quarterly options to meet your goals.
Step 6: Place A Trade
Choose the assets in which you want to trade the options, and place a "call" or "put" options trade.
The option type you trade will depend on whether you wish to speculate on the falling or rising market. Remember that buying an option is less risky compared to selling an option.
Having decided whether you want to place a sell or a buy trade, the next step is to select the premium (or margin and strike price with which you want to open the trade position).
Step 7: Regularly Monitor Your Position
After opening a position, track the market movement and the potential profit or loss. In the case of "In The Money", you may close it before the expiry date to maximize your gains.
If you are not in profit territory yet, exit your trade to expiry, and lose only the price you paid to open the position.
10. What Are Popular Options Trading Platforms In Australia?
Below is A list of popular options trading platforms in Australia:
11. Frequently Asked Questions (FAQs)
Can You Profit From Options Trading?
Yes and No. One of the best benefits of Options Trading is that it can amplify your profits.
This is because of the smaller investment price (the premium) compared to buying stocks directly. However, it can also amplify your losses if you use leverage, which makes it dangerous.
Let's make it clear with an example from options trading:
With regular stock trading, suppose you bought 100 stocks at $40, hoping the stock price will rise in the coming days. If the stock price moved in your speculated direction to $45 per stock, you could sell it at a profit.
The difference between the initial investment price of $4,000 and the increase to $4,500 is $500. It is the profit you have made (excluding brokerage costs).
You don't have to pay the full stock price when trading options. You can buy a call option for the same stock at a premium of $1 with a strike price of $40. Since options contracts include 100 stocks, you can buy 40 contracts at $100 each.
Now you hold 4,000 stocks, the same as your investment capital of $4000 from the stock example above. When the stock value rises from your set strike price, such as $40 to $45, the contract premium price also increases.
Always seek the help of a professional financial advisor before making any investment decision. Investing carries risk. The above are just some general options for educational purposes. All these options come with risk. This is not financial advice.
Can You Trade Stocks With Options?
Yes. Instead of owning the actual stock, you can buy or sell the stock with options at an agreed price on a predetermined future date from its seller.
Stock options trading in Australia is popular among traders as they need less initial capital compared to stock trading and have the potential to generate greater profits. However, they also have the potential to magnify your losses.
Instead of making a profit by buying or selling stocks, options traders earn profits from fluctuations in the stock price. Besides stocks, investors can trade options on various other assets such as indices, exchange-traded funds (ETFs), bonds, and commodities.
Can A Beginner Trade Options?
For beginners and long-term investors, stocks are a good choice. But, experienced investors who prefer short-term strategies often use options.
These experienced investors have more knowledge and a flexible way of investing.
Keep in mind that options trading is risky and not recommended for beginners.
Can You Do Options Trading In Australia?
You can trade options in Australia through exchange-traded options on the Australian Securities Exchange (ASX).
The ASX options market was established in 1976, offering a variety of choices, including options from over 70 companies, ETFs (Exchange-Traded Funds), and the S&P ASX 200 share price index.
Investors can purchase options from prominent Australian public companies when trading options on the ASX. You can access the list of these companies on the ASX website.
Can You Trade Options With CommSec?
Yes. However, to trade options, you require the following:
A CommSec Share Trading Account in the same name
A CommSec Margin Loan or CommBank account, or Commonwealth Direct Investment Account that is in the same name for trades settlement
If you don't have any of the above accounts, you will need to open an Options account to perform Options trading using CommSec online trading platform.
How Much Does Options Trading Cost?
There are two types of fees for options traders:
The price of the option contract or the premium price.
While the premium price is the same regardless of the trading platform you choose, the brokerage fee varies from one platform to another. So, consider this fee when deciding on an options trading platform in Australia.
Can You Buy Options on Westpac?
Yes. Westpac offers the facility to trade exchange options over an underlying share or index listed on the Australian Securities Exchange.
Existing Westpac Share Trading customers can set up an options trading account, sign in to their Westpac Share Trading account, and visit Products & Services > Derivatives > Options to start trading in Options.
How To Trade US Options In Australia?
You need to find a trading platform that lets you trade in global markets.
IG Markets is a popular US options trading platform in Australia that serves numerous international markets, including the US.
Options trading can be a lucrative investment strategy for profiting from underlying securities.
Its potential for higher returns, loss protection through hedging strategies, and flexibility in a fluctuating market make it an attractive alternative trading approach.
However, it's essential to recognise the inherent risks, mainly due to leverage. Traders may face substantial losses, including the entire premium for the options.
To succeed in options trading, one must conduct a thorough analysis, maintain market knowledge, and employ a disciplined approach with well-defined entry and exit points.
Awareness of the potential rewards and risks allows investors to make informed decisions and leverage options trading to enhance their investment portfolios.
|The advice and information on OzStudies.com is in general nature and should not be seen as a replacement for independent financial advice. We strongly encourage readers to consult with financial experts regarding their own financial decisions and investments.
Please note that the information presented on OzStudies.com is solely for educational purposes. Every individual's financial situation is unique, and the products and services we mention may not suit everyone. We do not provide financial advice, advisory, or brokerage services nor endorse buying or selling specific stocks or securities. It's essential to know that information might have changed since publication and past performance does not guarantee future results.
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