Friday, February 06, 2009

Writing put options

Writing options is generally regarded as a risky idea (unless as part of a hedging/spread strategy or similar). The reasoning is generally stated as being that the option writer receives a relatively small payment in exchange for accepting a much larger risk.

The current market turmoil has resulted in the premiums paid for put options being inflated above normal levels (not sure what is "normal"). Given that I believe that the Hang Seng index is reasonably attractive at these levels (i.e. I do not mind buying the index), I have written some put options against the Hong Kong Tracker Fund (which tracks the Hang Seng Index). My strike price is HK$12.00 (against a market price of HK$13.24 at the time of writing) and the contract is for one month.

If the Tracker Fund is higher than HK$12.00 on the fixing day, I will keep my money and pocket the option premium.

If the Tracker Fund is at HK$12.00 or less, I will end up buying Tracker Fund at HK$12.00 and keep the option premium.

Of course, if the market drops below HK$12.00 (less premium) then I will lose money. If the market rises above HK$13.24 (plus premium) then I would have been better off just buying the Tracker Fund outright. Essentially, I am betting that the market will go sideways or down less than 9% on the fixing date.

Since my primary motivation for this trade is to improve the yield on my cash balances, I have gone for a strike price which is well out of the money. I could have got a higher return by taking on more risk and selecting a strike price which is closer to the current market price.

1 comment:

Writing Put Options said...

Writing put and call options can be a great way to supercharge your trading portfolio. This offers traders a variety of benefits. As when you write, an option, you collect an up-front premium. That means you get money up front for selling the right to either sell an underlying stock or buy the underlying stock. Thanks a lot.