Share trading specialist firm Ausiex has highlighted the value instruments such as options can add to investment portfolios beyond providing potential upside advantages and mitigating downside risk.
To this end, Ausiex head of sales, trading and customer relationships Te Okeroa suggested the use of options can also act as a source of additional income for individuals that can be of benefit in challenging market conditions such as those currently being experienced locally.
Okeroa pointed out the three-year bond rate of around 4.2 per cent in July was equivalent to the nominal dividend yield on the benchmark S&P/ASX 200 Index for the first time since July 2011, illustrating the lack of choice investors face in generating the level of yield they may be chasing.
“Options offer sophisticated investors more than the ability to diversify by leveraging different underlying assets,” he noted.
“For example, writing covered call options can potentially provide income from the premiums received from writing these contracts.”
Specifically, the strategy he raised involves selling a call option on a stock or exchange-traded fund the investor has purchased. The writer receives a premium upon the sale of the option contract that in effect lowers the break-even point on the underlying investment.
Further, the premium received on writing an options contract increases as market volatility rises. According to Ausiex, this fact is something investors need to consider given forecasts of a volatile earnings season, a potential recession and uncertainty regarding the future interest rate policy of the Reserve Bank of Australia, all of which could result in corporations being unable to achieve their earnings targets.
“This [premium] adds to the benefits of options, potentially enhancing their total returns while reducing risks,” Okeroa said.
He acknowledged the use of these instruments comes with a level of risk as they remove some of the upside potential and that can reduce gains if the stock in question rallies well above the option strike price.
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