Options Trading in Australia: How to trade options
Options trading has become an increasingly popular investment strategy in Australia, allowing traders to capitalise on market movements while managing risk. Unlike traditional stock trading, options provide unique opportunities to earn income in down markets, leverage positions, and protect existing portfolios. However, this complexity comes with its own set of risks, making it essential for investors to understand the fundamentals before diving in.
In this guide, we will explore what options trading is and how it works in Australia, and enhance your trading experience with practical examples and option strategies.
What is options trading?
Options trading is a financial strategy that involves buying and selling options contracts, which are agreements that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price before a certain date. These assets can range from individual stocks, exchange-traded funds (ETFs), currencies, indices, to commodities. The contracts themselves are derivatives, meaning their value is derived from the performance of the underlying asset.
There are two main types of options: calls and puts. A call option gives the buyer the right to purchase the underlying asset at the strike price, while a put option grants the right to sell. The strike price is the predetermined price at which the option can be exercised, and the expiration date is the last day the option can be traded.
In essence, options trading provides flexibility and can be a powerful tool in an investor's arsenal, but it requires knowledge, experience, and careful strategy execution to be successful. It's a field where both opportunity and risk are amplified, making it as rewarding as it is challenging.
How does options trading work in Australia?
Options trading in Australia is a sophisticated financial market activity that allows investors to speculate on, hedge, or gain leveraged exposure to the price movements of various assets. Here's a detailed look at how options trading functions within the Australian financial landscape:
1. Regulatory framework
The Australian options market is regulated by the Australian Securities and Investments Commission (ASIC) and operates under the Australian Securities Exchange (ASX). These bodies ensure that all options trading activities are conducted in a transparent and fair manner, protecting investors and maintaining market integrity.
2. Options trading platforms
To engage in options trading, Australian residents must open an account with a stockbroker that offers options trading services. These brokers provide platforms where investors can trade options, and they must be licensed by ASIC. The choice of broker is crucial as it impacts trading fees, the user experience, and the tools available for making informed trading decisions.
3. Eligibility and assessment
Before an investor can start trading options, they must meet certain eligibility criteria set by the broker. This often includes being at least 18 years old, being an Australian resident, and passing an options trading assessment to demonstrate an understanding of how options work.
4. Types of options
In Australia, investors can trade two primary types of options: call options, which give the holder the right to buy an asset at a specified price (the strike price), and put options, which give the holder the right to sell an asset at the strike price. The decision to buy or sell options depends on the investor's market outlook and strategy.
5. Expiration dates and strike prices
Each options contract has a specific expiration date, after which the contract becomes void. The strike price is the agreed-upon price at which the underlying asset can be bought (in the case of a call) or sold (in the case of a put) if the option is exercised.
6. Premiums and orders
Investors pay a premium to purchase an option, which is the price of the contract. This premium is influenced by factors such as the asset's current market price, time until expiration, and implied volatility. Investors can place various types of orders, including market orders executed at current market prices and limit orders that set a maximum price for buying or a minimum price for selling.
7. Settlement and exercise
When an options contract is near its expiration date, the holder must decide whether to exercise the option or let it expire. If exercised, the holder of a call option can buy the underlying asset at the strike price, and the holder of a put option can sell. If it is not profitable to exercise, the option may be sold before expiration if it retains value or allowed to lapse.
8. Risks and rewards
Options trading offers potential for high leverage and significant profits but also carries unique risks, including the potential for complete loss of the premium paid for the option if the contract is not exercised. It is essential for investors to understand these risks and implement appropriate risk management strategies.
In summary, options trading in Australia offers a versatile tool for investors to manage risk, speculate on price movements, and gain exposure to a range of assets. However, it requires a solid understanding of market dynamics, careful strategy, and adherence to regulatory requirements.
You can learn option strategies
In the world of finance, options trading is a versatile tool that can be used for various purposes, from hedging to speculation. Here are six fundamental options trading strategies that are commonly used in Australia and around the world.
Long Call option strategy
A Long Call strategy is when an investor buys a call option, giving them the right, but not the obligation, to buy an underlying asset at a specified strike price before the option expires. This strategy is used when the investor is bullish on the underlying asset and expects its price to rise. In this approach, the highest possible loss is capped at the cost of the option premium, whereas the potential for profit is virtually limitless, given that the value of the underlying asset could increase without bound.
Long Put option strategy
A Long Put strategy involves buying a put option, which gives the investor the right to sell the underlying asset at the strike price before the option's expiration. This strategy is employed when the investor is bearish on the asset, anticipating a decline in its price. The maximum loss is capped at the premium paid for the put option, and the profit potential increases as the price of the underlying asset falls below the strike price.
Short Call option strategy
Employing a Short Call strategy entails the sale of a call option, which binds the seller to part with the underlying asset at the predetermined strike price should the option be executed. This tactic is typically adopted when an investor holds a bearish or neutral outlook on the asset and is prepared to sell it if the option is triggered. The greatest gain from this strategy is confined to the premium obtained from the sale of the call option, whereas the risk of loss is boundless, as there is no ceiling on how high the price of the underlying asset might soar.
Short Put option strategy
In the context of a Short Put strategy, an investor undertakes the sale of a put option, which commits them to deliver the underlying asset at the specified strike price should the option be executed. This strategy is suitable for investors who are bullish or neutral on the asset and are willing to own the asset if the option is exercised. The maximum profit is limited to the premium received from selling the put option, while the potential loss is theoretically unlimited if the asset's price falls significantly.
Covered Call option strategy
A Covered Call strategy is when an investor who already owns the underlying asset sells a call option. This strategy is used to generate additional income from the premium received while still retaining ownership of the asset. The investor is willing to sell the asset if the option is exercised, as they already own it. The maximum profit is limited to the premium received plus the difference between the strike price and the current market price if the option is exercised.
Protective Put option strategy
A Protective Put strategy involves buying a put option for an underlying asset that the investor already owns. This strategy is used to protect against a potential decline in the value of the asset. The investor is bearish on the market or wants to hedge against a downturn. The strategy's downside risk is capped at the cost of the put option premium, offering a protective cushion against potential declines in the asset's value.
How to trade options in Australia
Trading options in Australia through platforms like Moomoo involves a series of steps that cater to both new and experienced traders. Moomoo, known for its user-friendly interface and advanced trading tools, offers a comprehensive platform for options trading. Here's a detailed guide on how to trade options using Moomoo as an example:
Open an account with moomoo: The first step to trading options in Australia with Moomoo is to open a brokerage account. You can do this by visiting the moomoo website or downloading the moomoo app, both available for iOS and Android devices. Complete the online application form, providing the necessary personal information.
Develop a trading plan: Before you start trading, it's crucial to develop a clear trading plan. This should include your investment objectives, the strategies you plan to use, your risk tolerance, and your entry and exit points. Moomoo provides educational materials that can assist in creating a solid trading plan.
Fund your account: To begin trading, you need to fund your moomoo account. Ensure that you deposit sufficient funds to cover your initial options trades.
Use the Options Chain: Options serve as a potent financial instrument that enables investors to mitigate exposure to risk, amplify the impact of their investments, and enhance their earnings. To choose options for a specific stock, navigate to the Options Chain feature on Moomoo. Here's how to find and utilise the Options Chain:
Navigate to the "Detailed Quotes" section for a specific stock.
Select "Options" and then "Chain" from the menu at the top of the page.
By default, all options for a specific expiration date will be shown. To filter and see only calls or puts, simply tap on "Call/Put".
Switch to a different expiration date by selecting the desired date.
Options that are out-of-the-money are shown in white, and those that are in-the-money are highlighted in blue. To access further details on the options at hand, you can scroll across horizontally.
Place your trade: When you've chosen a contract, you can place your trade. At the bottom of the screen, you can switch between different trading strategies. Review your order carefully before submission to ensure all details are correct.
Monitor and manage your trades: After placing your trade, it's important to monitor your positions and the market closely. Moomoo provides real-time market data and alerts to help you stay informed. Use the platform's tools to manage your trades, including setting stop-loss orders to limit potential losses.
Settlement and exercise of options: As your options contracts approach their expiration date, you'll need to decide whether to exercise your options or let them expire.
Options trading examples
To better understand options trading, let's explore some practical examples that illustrate different strategies and their outcomes. These examples will help clarify how options can be used in various market scenarios.
Example 1: Long Call Option
Suppose you believe that the share price of Company XYZ, currently trading at $50, is going to rise significantly in the next few months. You decide to buy a call option with a strike price of $55, expiring in three months. You pay a premium of $3 per share.
The share price of Company XYZ rises to $60 by the expiration date. You can exercise the option to buy the shares at $55 and immediately sell them at the market price of $60, making a profit of $2 per share ($60 - $55 strike price - $3 premium). If you bought 100 shares, your total profit would be $200.
The share price remains below $55 by the expiration date. The option expires worthless, and you lose the entire premium paid, which is $300 in this case.
Example 2: Long Put Option
You are concerned that the share price of Company ABC, currently at $40, might drop. You decide to buy a put option with a strike price of $40, expiring in two months, and pay a premium of $2 per share.
The share price of Company ABC falls to $35 by the expiration date. You can exercise the option to sell the shares at $40, making a profit of $3 per share ($40 strike price - $35 market price - $2 premium). If you bought 100 shares, your total profit would be $300.
The share price remains above $40 by the expiration date. The option expires worthless, and you lose the premium paid, which is $200 in this case.
Example 3: Covered Call Option
You own 1000 shares of Company DEF, currently trading at $30, and you believe the price will not rise significantly in the next month. You decide to sell a call option with a strike price of $32, expiring in one month, and receive a premium of $1 per share.
The share price of Company DEF remains below $32 by the expiration date. The option expires worthless, and you keep the premium, making a profit of $1000 ($1 premium per share times 1000 shares).
The share price rises to $35 by the expiration date. The option is exercised, and you are obligated to sell your shares at the strike price of $32. While you made a profit from the premium, your potential profit from the share price increase is capped.
Example 4: Protective Put Option
You own 1000 shares of Company GHI, currently trading at $50, and you are worried about a potential drop in price. You buy a put option with a strike price of $48, expiring in three months, and pay a premium of $1.50 per share.
The share price falls to $45 by the expiration date. You exercise the put option and sell your shares at $48, mitigating your loss. Without the put option, your loss would have been $5000, calculated as the difference between the original price of $50 and the current price of $45, multiplied by 1000 shares. With the put option, your loss is reduced to $3500, calculated as the difference between the original price of $50 and the current price of $48, plus the $1.50 premium, multiplied by 1000 shares.
The share price rises to $55 by the expiration date. The put option expires worthless, but your shares have appreciated in value, providing a profit that more than covers the premium paid for the put option.
These examples demonstrate the potential outcomes and strategies associated with options trading. They highlight the importance of understanding the dynamics of options and how they can be used to manage risk, generate income, or speculate on market movements.
Start options trading with paper trading
Once you have mastered the basics behind options trading, including
How to recognize a good opportunity
How to choose the right terms for a purchased contract
When to exercise an option, sell an option, or let an option expire
You can then apply what you've learned to options trading.
Paper trading is a great way to start this risk-free journey. You can set up paper trading with moomoo. Once you've gained experience trading options contracts, you're ready to start your real options trading.
What are the benefits of trading options in Australia?
Trading options in Australia comes with a variety of benefits that can be highly advantageous for both new and experienced investors. Here are some of the key benefits that make options trading an attractive proposition in the Australian financial market:
1. Flexibility and diversification
Options trading provides a high degree of flexibility, allowing investors to tailor their strategies to suit their market outlook, risk tolerance, and investment goals. This flexibility also extends to diversification, as options are available on a wide range of underlying assets, including stocks, indices, ETFs, commodities, and currencies. Investors can spread their risk across different asset classes and market sectors.
2. Leverage and potential for higher returns
One of the most significant benefits of options trading is the ability to use leverage, which allows investors to control a large number of shares with a relatively small initial investment. This can amplify potential returns, enabling investors to profit significantly when their market predictions are correct.
3. Hedging and risk management
Options are an excellent tool for hedging existing positions and managing risk. Investors can use options strategies like protective puts to guard against potential losses in their stock portfolios. This helps in mitigating the impact of market downturns and provides a safety net for long-term investments.
4. Access to global markets
Many Australian brokers offer access to international options markets, allowing investors to trade options on global stocks and indices. This provides an opportunity to gain exposure to foreign markets and diversify investments beyond local assets.
5. Income generation
Options trading can be a source of additional income. Investors can generate regular income by writing covered calls on stocks they already own or by selling cash-secured puts. This can be particularly attractive to those looking for alternative income streams.
6. Speculation on price movements
Options allow investors to speculate on the price movements of underlying assets without actually owning the asset. This can be useful for taking advantage of market trends or short-term fluctuations without committing to a long-term investment in the asset itself.
7. Strategic advantages
Options trading offers strategic advantages, such as the ability to implement more complex trading strategies like spreads, straddles, and strangles. These strategies can be used to profit from various market conditions, including volatility and price consolidation.
8. Market neutral strategies
Options can be used to create market-neutral strategies that are designed to perform well regardless of the direction of the market. This can be particularly useful for investors who are uncertain about future market movements or who want to reduce the overall risk of their portfolios.
Final words on options trading in Australia
Options trading provides australian investors with leverage and flexibility but also carries significant risks. It's crucial to manage these risks with proper strategies and not to invest more than you can afford to lose. Given the complexity, seeking advice can be beneficial, and it's important to approach options trading with a well-thought-out plan. Always keep in mind that while the potential for profit exists, so does the potential for loss.
In addition to options trading, common investment strategies include stock trading. Keep in mind that you don't have to choose one or the other. Options can always be combined with stock trading strategies to provide higher returns and better manage risk.