Are you looking to learn more about call and put options in Australia? If so, then this guide is for you. Here you will gain a comprehensive understanding of these derivatives and the ins and outs of how they work within the Australian financial market.
This guide provides an in-depth look at different types of options, key associated terms, and various trading strategies available within Australia. You don’t have to be an expert to understand this material; even those new to investing can benefit from knowing the basics about call and put options.
What are call and put options?
Call and put options are derivatives that give the holder the right, but not the obligation, to buy or sell shares at a predefined price within a specified time. They provide leveraged exposure to price movements in the share market without having to issue large amounts of capital.
Understanding what call and put options can be complicated; however, taking some time to learn the basics can assist investors seeking opportunities for diversification or the ability to hedge certain types of investments with limited costs. Comparing different providers and understanding how changes in volatility levels will impact potential opportunities or losses is critical when deciding which option best suits your requirements.
Types of options
The two main types of options in Australia are the American style and the European style. American-style options can be exercised any time before it expires, while European-style options can only be exercised at the expiration date. In addition to these two main types of options, there are several variations, including covered calls, naked calls and straddles, which all have different risk profiles.
Covered calls involve writing (selling) a call option on a stock you own, and the risk is limited to the cost of the option premium. Naked calls involve writing a call option without owning the underlying asset, so any increase in value may result in unlimited losses. Straddles involve buying both put and call options on an underlying asset at the same strike price, so if there is significant movement in either direction, traders can take advantage of it.
Key terms: When you’re trading call and put options
There are specific terms that you need to be familiar with. ‘Intrinsic Value’: The amount by which the option’s strike price is in the money (ITM). ‘Time Value’: The additional value of an option due to remaining time until expiry. ‘Delta’: A measure of how much the option will move relative to the underlying stock. ‘Volatility’: A measure of how much the value of an asset is likely to fluctuate over time. ‘Strike Price’: The price at which the option will be exercised if it’s in the money at expiry.
It’s also important to know when it may (or may not) be suitable to buy or write call and put options. If the market is highly volatile, options are an excellent way to hedge your risk and gain leverage over your investment. However, if the market is less volatile, consider other investments, as you are unlikely to find many opportunities from buying or writing options in this environment.
What are the risks associated with call and put options?
As with any investment, some risks are associated with trading call and put options. If the price of the underlying asset moves in an unexpected direction or fails to reach the strike price before expiry, you may experience losses. Therefore, it’s crucial to understand how changes in volatility levels can impact potential earnings or losses.
In addition, there are also other fees associated with trading options, such as brokerage fees and commissions which should be considered when making investment decisions. It’s essential to weigh the risks and rewards of investing in call and put options to ensure you make a well-informed decision that best suits your goals.
Understanding the taxation implications associated with trading options, such as capital gains and losses, is also essential. Capital gains tax is applied when you succeed upon the exercise or sale of your option, and capital losses can be offset against other capital gains in the same financial year.
What are the benefits of trading call and put options?
The main benefit of trading options is that you can make significantly valuable trades with a relatively small investment. You can also use them to hedge against potential losses in other investments or take advantage of market movements. Options can also be used for speculative purposes, allowing you to leverage your capital by controlling a more significant portion of the underlying asset.
Another advantage of options is that a wide range of strategies is available, from simple short-term trades to more complex long-term investments. Investors can tailor their strategy to their risk appetite and investment goals.
Options generally have shorter holding periods than other investments, allowing investors to take advantage of short-term market movements without months or years of holding an asset.