For many investors, options can be a confusing topic. Options are ‘derived’ instruments (i.e. not the actual asset), making it more difficult to understand them versus stocks or ETFs, even for experienced investors. Let’s discuss three things you should know about listed options in Hong Kong.
How do options work?
First of all, what is an option? An option is a contract where the buyer has the right but not obligation to buy or sell an underlying security at a set price on a specific date. In this case, the “underlying security” would be a stock that you want to trade and “the set price” would be called “the strike price”. The date is also obvious as it is the date you exercise the option.
Before we proceed, let’s first understand a couple of rules:
The strike price is always predetermined by the issuer and will be set based on the stock price to strike a balance between them selling options at a cheap enough price that there is demand for it but not too cheap where they’re losing money from every sale.
In Hong Kong, if you’re trading an American style option (options that you can exercise anytime before expiry), then it expires three business days after the last day of trading in which it has value. This means if a company announces a dividend/split/rights issue within this pe, you won’t have to wait until expiration to claim your rights because you have all the rights from the announcement date onwards.
There’s a big difference between being long and being short an option. If you’re buying, you’re considered to be long. While you’re selling it, you’re considered short. This means that when something rises in value, the seller of the options will lose while the buyer of the options gains.
How are options priced?
What determines how much an option costs aside from its underlying security? As said earlier, options have a predetermined strike price, affecting their price. For example, a stock trading at $10 with a $9 or $11 option would have more demand than having a $5 or $7 option because investors know that they only need to come up with an extra $1 or less to turn a profit of$4 if the stock rises. You’re aware of this and set your sales price accordingly if you’re selling.
Types of options
Options are generally separated into two subgroups – puts and calls. Puts are used to hedge against underlying security falling in value. In contrast, calls can be used either for speculation (i.e. betting that the stock will go up) or as part of a strategy known as “spread trading”. For example, you buy put options on one market index/stock/asset class while simultaneously selling call options on another asset that is moving similarly so that if there’s any difference between how much they move, you’ll gain.
Puts are further divided into “calls” where the buyer has the right but not obligation to sell at a predetermined price or “puts” where the buyer has the right but not obligation to buy at a predetermined price. Calls are used to speculate that an underlying security will go up in value, while you can use puts for hedging against falling security prices. If there’s high demand for calls and low demand for puts (or vice versa), it could indicate that investors view that stock as risky or safe, respectively.
Hong Kong Exchange offers listed options, an options trading facility available for trading on the Main Board Securities Market of HKEx and the Growth Enterprise Market (GEM). Investors can choose from a large number of contracts to trade. If you are new to trading and want to trade in listed options, contact a reputable online broker from Saxo Bank and start trading on a demo account before investing any of your own money.