How to trade the Australian Options MarketDecember 1, 2021
Australian stocks are known throughout the world for their high dividend yields. It can be attributed to two main factors. Firstly, many foreign multinationals listed on the ASX pay dividends to shareholders in their home countries. Secondly, many mining companies listed on the Australian stock exchange pay out significant dividends every quarter due to how profitable mining has been in Australia during recent years.
Since January 2009, an additional way for investors with an appetite for speculative growth to invest in Australian assets has been available – through buying options on Australian securities.
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An option is a derivative security that allows the buyer to buy or sell another underlying asset at a specific price or on a given date. The vast majority of the time, options are used to lower risk for investors, but you may also trade them speculatively in the hopes of significant gains.
Australian options are typically classified as either a ‘call’ option or a ‘put option. A call gives its owner the right to purchase an asset at a specific strike price on or before expiration. Meanwhile, put owners are given the right to sell an asset at a fixed strike price until expiry. An Australian call generally increases in value as the underlying security closes higher relative to the strike price while simultaneously decreasing in value if it falls below that same strike level. The opposite is true for put values which increase when their associated stock falls and decrease as it rises.
Options traders can also buy or sell either an out of the money (OTM) call or put, which has no intrinsic value and instead trades based on expectations of future price direction. Buying an OTM option is speculative because its highest possible payoff will occur if the underlying security moves considerably in either direction before expiration; however, its maximum loss is known and limited to the premium paid for the option itself. Therefore, buying an out-of-the-money option allows investors to benefit from movement in security without requiring them to predict whether it will increase further (in the case of a call option) or decrease substantially (a put).
Typically options with more time left until expiry are worth more than ones with less time. It is due to the uncertainty associated with the timing of an event, specifically whether or not it will occur before the option expires. It creates a higher degree of unpredictability for out-of-the-money options, so they are more likely to have intrinsic value, which increases as expiration draws near.
The ASX has different types of listed options that investors can buy and sell.
These are Australian style ‘calls’ and ‘puts’, which give their owner the right but not obligation to buy or sell at a fixed price by expiry. American style ‘calls’ and puts’ oblige owners to trade once certain conditions are met. European style options, where the right to trade is forfeited if not executed by the expiration date.
Australian style options are more common on the ASX because they can be traded at any time before expiry, thus allowing for greater flexibility and opportunity. It differs from American style options, which typically have much shorter lifespans of one to six months. Since there is less time for price fluctuations, these options are cheaper and inherently riskier than their Australian counterparts.
European-style options are the most restrictive because they expire only after a month or two, during which an investor cannot trade them until expiry. It means that traders must correctly predict within a relatively short period whether the price will rise or