Bill Stacy
11th August 2008, 07:48 PM
I asked Chris at HC for an explanation on how to trade the XJO.
XJO Index options
Since the middle of May 2008, the Australian Share Market has fallen from almost 6,000 points to levels below 4,800. During this time many clients would have experienced significant falls in the value of their long term portfolios. There are strategies clients can use to offset these portfolio losses or even profit from a fall in the market – this is known as hedging and
shorting.
One method of hedging that many clients would be familiar with is 100% Finance (or Protected Equity), where a put option is purchased to protect medium to longer term equity positions. Entering individual protective positions on an existing portfolio that has already fallen considerably can be difficult to time, as well as costly from an execution perspective.
An alternate method of hedging a long term position is through an index put option. For example, if you’re holding BHP shares and expected the share price to decline in the short to medium term, but did not want to sell the shares because you have a long term outlook, you could buy an index put option to offset the decline. The index put option will increase in value
as the market (and most likely BHP) falls. This increase in value will offset a fall in the long term portfolio.
The most common index option is an XJO index option, being an option over the S&P/ASX 200 market index. The XJO is comprised of the top 200 companies on the ASX, weighted according to the individual company’s market capitalisation.
If you would like to read more information on index options, you might like to visit http://www.asx.com.au/products/options/index_options.htm or read the brief summary below.
There are some important differences between index options and normal options over shares that should be noted.
- Index options are usually cash settled upon expiry, rather than deliverable.
- The exercise price and premium of index options are usually expressed in points. An Index Multiplier is then applied to give a dollar amount. For example the multiplier on the XJO is $10 per point, meaning that to buy an index option with a premium of 50 points would cast $500.
- Settlement price is determined by the opening price index calculation (OPIC) on the expiry day. There are a few features that make index options more suitable to this current market climate.
- If you anticipate a short term decline in the market, you could purchase an Index Put Option to offset the decline in your portfolio.
- The execution costs of entering one trade is far less than entering an individual trades for each position in a portfolio.
- As the XJO is comprised of a weighted average of the top 200 ASX companies, the index generally fluctuates with less noise than individual companies.
XJO Index options
Since the middle of May 2008, the Australian Share Market has fallen from almost 6,000 points to levels below 4,800. During this time many clients would have experienced significant falls in the value of their long term portfolios. There are strategies clients can use to offset these portfolio losses or even profit from a fall in the market – this is known as hedging and
shorting.
One method of hedging that many clients would be familiar with is 100% Finance (or Protected Equity), where a put option is purchased to protect medium to longer term equity positions. Entering individual protective positions on an existing portfolio that has already fallen considerably can be difficult to time, as well as costly from an execution perspective.
An alternate method of hedging a long term position is through an index put option. For example, if you’re holding BHP shares and expected the share price to decline in the short to medium term, but did not want to sell the shares because you have a long term outlook, you could buy an index put option to offset the decline. The index put option will increase in value
as the market (and most likely BHP) falls. This increase in value will offset a fall in the long term portfolio.
The most common index option is an XJO index option, being an option over the S&P/ASX 200 market index. The XJO is comprised of the top 200 companies on the ASX, weighted according to the individual company’s market capitalisation.
If you would like to read more information on index options, you might like to visit http://www.asx.com.au/products/options/index_options.htm or read the brief summary below.
There are some important differences between index options and normal options over shares that should be noted.
- Index options are usually cash settled upon expiry, rather than deliverable.
- The exercise price and premium of index options are usually expressed in points. An Index Multiplier is then applied to give a dollar amount. For example the multiplier on the XJO is $10 per point, meaning that to buy an index option with a premium of 50 points would cast $500.
- Settlement price is determined by the opening price index calculation (OPIC) on the expiry day. There are a few features that make index options more suitable to this current market climate.
- If you anticipate a short term decline in the market, you could purchase an Index Put Option to offset the decline in your portfolio.
- The execution costs of entering one trade is far less than entering an individual trades for each position in a portfolio.
- As the XJO is comprised of a weighted average of the top 200 ASX companies, the index generally fluctuates with less noise than individual companies.