OFRM

Topic: An Introduction to Options Markets

1. Check out the ASX website for up-to-date details on the options market in Australia.
Acquire information on the following:
i) What is the contract size for its share options derivatives?
100 shares

ii) What is the contract expiry date for index options?

3rd Thursday of the month, unless otherwise stated by ASX.

iii) What is the contract expiry date for share options?

Last Thursday of the settlement month

iv) What is the longest expiry length for an option?

3 years

v) What is an index multiplier? What is the index multiplier for the ASX200 index
option?
$10 is the index multiplier. The multiplier indicates the $ value of each index
point

2. Tutors should explain the following tables to students.

From the ASX website

Index options

Index options give you exposure to the securities comprising a share market
index.

They offer you similar flexibility to that provided by options over individual stocks,
while allowing you to trade a view on the market as a whole, or on the market
sector covered by the particular index.

While the value of a share option varies according to movements in the value of
the underlying shares, an index option varies according to movements in the
underlying index.

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Features
Underlying
ASX approved indices (currently the S&P/ASX 200 Index)
asset
Exercise style European
Cash settled based on the opening prices of the stocks in the underlying index on the morning
Settlement
of the last trading date.
Expiry day The third Thursday of the month, unless otherwise specified by ASX.
Last trading Trading will cease at 12 noon on expiry Thursday. This means trading will continue after the
day settlement price has been determined.
Premium Expressed in points
Strike price Expressed in points
Index
A specified number of dollars per point e.g. AUD $10
multiplier
Contract value The exercise price of the option multiplied by the index multiplier

Some of the differences between index options and options over securities are:

• Index options are cash settled.

• Index options are European in exercise style. This means the holder can only exercise an index option on
the expiry day.

• The strike price and premium of an index option are expressed in points. A multiplier is then applied to give
a dollar figure.

Index options are cash settled

The settlement amount is based on the opening prices of the stocks in the
underlying index on the morning of the maturity date. As the stocks in the
relevant index open, the first traded price of each stock is recorded. Once all
stocks in the index have opened, an index calculation (the Opening Price Index
Calculation (OPIC)) is made using these opening prices.

Options are currently available over the following ASX indices: S&™/ASX 200™ Index -
code XJO

Benefits of index options

• The ability to trade all the stocks in an index with just one trade.

• Investing in index options approximates trading a share portfolio that tracks that particular index. By using
options over an index, you can trade a view on the general direction of the market with just one trade. For
example, if you are bullish on the market, you could buy a call option over an index. This gives you
exposure to the broader market which the index represents, without having to choose a particular stock.

• Leverage - index options, like ordinary options, provide leveraged profit opportunities. When the market
rises (or falls), percentage gains (or losses) are greater than rises (or falls) in the underlying index.

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• Protection for a share portfolio - when you buy shares you are exposed to two types of risk:

1. Company risk - the risk that the specific companies you have bought into will underperform.

2. Market risk - the risk that the whole market underperforms, including your shares.

• You can protect your shares against market risk by buying an index put option. If your bearish market view
proves correct, the profits on your put option will at least partly compensate you for the loss of value in the
stocks in your portfolio.

• Low trading costs - since the amount of capital outlaid in an option trade is usually much lower than that
involved in a share transaction providing similar market exposure, brokerage costs are often lower in option
trades.

Equity Options

Equity options give you exposure to the securities they are listed over. The value
of an equity option varies according to movements in the value of the underlying
shares.

Features
Underlying asset Equity options are available over many of the top 100 shares
Exercise style American
Settlement Physically settled. (Shares change hand on expiry)
Expiry day The last Thursday of the month, unless otherwise specified by ASX.
Last trading day Trading will cease at 4.20pm on expiry Thursday.
Premium Expressed in cents
Strike price Expressed in cents
Contract size Generally 100 shares pre contract
Contract value The exercise price of the option multiplied by 100

Equity option holders do not enjoy the rights due to shareholders - e.g., voting
rights, dividends or franking credits. A call holder must exercise the option and
take ownership of underlying shares to be eligible for these rights.

After the option's expiration date, the contract will cease to exist. At that point
the owner of the option who does not exercise the contract has no "right" and the
seller has no "obligations" as previously conveyed by the contract.

Benefits of equity options

• Purchasing equity put options allows you to lock in a predetermined sale price for your shares. Providing
protection from a market downturn

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• Writing calls against stock already held generates additional income over and above dividends.

• Leverage - equity options provide leveraged profit opportunities. When the market rises (or falls),
percentage gains (or losses) are greater than rises (or falls) in the shares.

• Low trading costs - since the amount of capital outlaid in an option trade is usually much lower than that
involved in a share transaction providing similar market exposure, brokerage costs are often lower in option
trades.

2. Are index options on the ASX considered to be European or American options? What
does this imply?
ASX Index options are European. This indicates you can only exercise them at
the expiry date.

3. What is the benefit of trading index options? What benefits, if any, do index options
have over share options?
- Leverage, protection of a share portfolio, low trading costs, can trade all stocks
of an index with one trade

4. What is an efficient market and why is it important for derivatives markets?

Without an efficient market, derivative instruments cannot be correctly priced.

5. What types of transaction costs are you faced with when trading options?
Broker commission rates
Bid-ask spread
Clearing house fee
Exchange fee

6. If you wanted to physically trade an option here in Australia how would you go about
it? Work out which brokers and what transaction costs they would charge.
A question like this may well appear in the exam and so its worth students
researching this question. Usually brokers charge a fixed fee ~$50 to cover all
costs.

7. What is the main taxation ruling that governs options taxation processes?

There is no specific taxation ruling that applies to options. However, ITAA1997

covers general taxation matters relating to options.

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