When you write a Covered Call, you must lodge your shares with the Option Clearing House (OCH) as margin. This step is required to ensure that if you are exercised your shares are immediately available to be sold.
As you are offering the shares as security, no further margin is required.
There is a second method whereby someone who owns shares may use those shares as collateral for the purpose of writing options. The OCH will assign collateral value to shares that have been lodged as security, this system works in the following manner:
The OCH has established three tiers of shares acceptable to be lodged as security:
Tier One Any share that has exchange traded options may be lodged as collateral. For example, you could lodge NCP shares for the purpose of writing BHP options.
Tier Two Is any share or units in entities within the ASX Fifty Leaders which do not fall within the shares listed in Tier One.
Tier Three Is any exchange traded security of Tier One shares, other than fully paid ordinary shares that meet the following criteria: Issued capital represented by the securities must be a minimum of $100 million, the minimum monthly volume must be in excess of 100,000 units and the minimum closing price must be at least $0.50.
In defining how much the collateral you have lodged is worth, the OCH applies a 30% discount to the market value of your shares.
The purpose of applying a discount is to guard against a sudden change in the market value of your shares. Such a treatment provides both you and the OCH with a buffer against unexpected market volatility.
Collateral must be lodged with the OCH by 4 pm of the day in which the trade is initiated. So if you put a trade into the market in the morning you must lodge your collateral by 4 pm on the same day. If you do not, the OCH will treat it as an uncovered position and full margins are payable in cash by 11 am on the following morning.
As well as taking shares as security, the OCH will accept a range of other financial instrument such as bank guarantees, certificates of deposit and non bank bills of exchange.
Let’s start trading!
Before dealing in the options market, you must complete and lodge the OCH Client Agreement Form.
This document outlines that you are aware of the mechanics of the options market, understand its risks and accept to be bound by its requirements. OCH forms are available from your broker and are usually included in the account opening packs which they will provide.
The options market also has slightly different settlement requirements to those associated with dealing in equities (shares). Settlement on options is required within 24 hours, or T+1. (Equity settlements are required within 3 business days, T+3).
Therefore, when you write covered calls, your account will be credited with the premium payment the next business day.
If you ever choose to take (buy) a Call or Put option contract(s), then most brokers will insist on a cash balance being established in your account before agreeing to enter the market on your behalf.
Daniel Kertcher is a licensed stock market educator. Daniel has trained many people from North America, Australia and Europe in various trading systems. Join his trading mail list http://www.platinumpursuits.com and read more about him at his personal website http://www.danielkertcher.com
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January 28th, 2008 by admin
A decade ago corporate governance mavens urged boards to pay managers more in stock than in cash to promote an alignment of interests between managers and shareholders. The response was tremendous, a bit like the apocryphal story of Lady Astor’s famous quip on the Titanic: “I asked for ice, but this is ridiculous.” What the governance gurus got was a proliferation of payment not in stock that was the functional equivalent of the forgone cash but instead stock options with a value vastly exceeding what the cash payment could reasonably have been. The explosion of option-based compensation remains one of the most controversial subjects in corporate governance history.
Some say that the widespread use of stock options in the United States simply reflects the priority given to this alignment goal in the United States and that its relative infrequency in Europe and elsewhere reflects the absence or irrelevance of this goal. However, the talk of alignment is more myth than truth and too often represents an attempt to sanitize management compensation packages that conflict with shareholder interests.
Stock Option Myths
No evidence indicates that the prevailing structure of executive compensation in the United States comes anywhere close to aligning manager and shareholder interests. On the contrary, a great deal of evidence demonstrates that the compensation structure is random. Many corporations give their managers stock options which increase in value simply through earnings retention, rather than because of improved performance resulting from superior deployment of capital. By retaining and reinvesting net income, managers can report annual earnings increases without doing anything to improve real returns on capital.
Buffett makes the point: You can get the same result personally while operating from your rocking chair. Just quadruple the capital you commit to a savings account and you will quadruple your earnings. You would hardly expect hosannas for that particular accomplishment. When that happens, stock options rob the corporation and its shareholders of wealth and allocate the booty to the option. Indeed, once granted, stock options are often irrevocable and unconditional and benefit the grantees without regard to individual performance a form of instant robbery.
Even if stock options encourage optionees to think as shareholders would, optionees are not exposed to the same downside risks as shareholders are. If economic performance improves and thestock price rises above the exercise price, the optionees will exercise the option and share in the increase with shareholders. But if economic performance is unfavorable and the stock price remains below the exercise price, optionees simply will not exercise the option. Shareholders suffer from the corporation’s unfavorable performance, but an option holder does not.
These awards also exacerbate the misalignment of interests between corporate option holders (usually senior executives) and other workers. The awards dramatically increase the compensation differential between highly paid executives and ordinary laborers, a ratio which is significantly higher in the United States than it is in Europe and elsewhere. Accordingly, when stockoptions are used, they should be spread throughout the employee base as GE has done rather than limited to the top dogs.
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January 28th, 2008 by admin
The direct cost to shareholders of stock option compensation is the dilution of their ownership interest. A common managerial response to the dilution is to buy back outstanding shares. The trouble with that solution is that it devours corporate funds that might be more profitably deployed. Shocking indirect costs are accounting rules that fail to require employee stock options to be recorded as an expense on the income statement. This translates into earnings per share figures that overstate actual earnings for companies with executive stock options outstanding. Even the diluted earnings per share figure does not reflect these costs.
Accordingly, you must adjust earnings figures for the cost of options. Doing this is not easy, however, for not all information is necessarily found in the financial statements. You need to examine the footnotes for something called overhang, which is the percentage of the company that outstanding stock options would represent if they were exercised. The average percentage has mushroomed from under 10% a few years ago to nearly 15% now.
Still, the actual cost of options is not presented directly, though there is some footnote disclosure about this. The real cost equals the price at the time of exercise minus the amount the executive pays (the exercise price). This is the truest measure of cost because the company could have generated that much by selling the optioned shares to others at the prevalent price instead of at the option price. The cost of executive stock options is substantial, averaging about 5% of annual earnings among S&P 500 companies and in some cases amounting to half of reported earnings, including at Yahoo!, Polaroid, and Palm.9 In less dramatic but still striking examples, if stock options were recorded as a cost, the 1999 earnings of some major companies would be slashed: Cisco, 24%; Microsoft, 12%; IBM, 8%; and Oracle, 16%.10 These cost effects extend for many years, depending on the life of the options. At many companies, options have a life of five years. Increasingly, companies extend their lives to as long as 10 and 15 years.
Accountability
Legal rules are ill equipped to police executive compensation. The general stance of U.S. courts is to evaluate compensation issues, if at all, under a waste standard. This standard rarely upsets corporate decisions. Waste requires pretty much the irrational trashing of corporate assets in ways akin to dumping truckloads of cash into the Hudson River. In the case of executive compensation, U.S. courts are quite deferential to management indeed.
As for securities disclosure laws, the SEC requires substantial and focused disclosure of top executive compensation in comparative performance charts. Nevertheless, corporations continue to structure executive compensation packages so that they don’t show up in the bottom-line numbers. For example, after accounting standard setters ruled that a reduction in the exercise price of a previously issued option had to be recorded as an expense on the income statement, many companies chose instead to extend the life of the option.
Without effective legal or accounting regulations, the chief job of policing executive compensation lies with the corporate board. Board members must insist that executive compensation peg individual contributions to corporate performance. Measuring executive performance by business profitability is the most definitive yardstick with regard to shareholder as well as labor interests. When measuring performance, companies should reduce earnings by the capital employed in the relevant business or by the earnings the firm retains.
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January 20th, 2008 by admin
What are options?
An option is a contractual agreement that gives the holder the right to buy (call option) or sell (put option) a fixed quantity of a security or commodity (for example, a commodity or commodity futures contract), at a fixed price, within a specified period of time. May either be standardized, exchange-traded, and government regulated, or over-the-counter customized and non-regulated.
An option is a security, just like a stock or bond, and constitutes a binding contract with strictly defined terms and properties.
The Chicago Board Options Exchange (CBOE), located in Chicago, is one of the world’s largest options exchanges with an annual trade of over 450 million options contracts. It was established in 1973 when it created and listed the first exchange-listed standardized stock options.
Once the CBOE was instituted, the listed option industry began, and investors had a world of endless investment choices previously unavailable. Prior to the creation of the CBOE, investors had limited choices of where to invest their money. They could either be long or short individual stocks, or they could purchase treasury securities or other bonds.
Call Options and Put Options
Options take many forms. If you own a house or have automobile insurance, you have already dealt with the basic forms of options in your everyday life. However, in the listed options world there are only two kinds of options, Call and Put.
A call option is a financial contract between two parties, the buyer and the seller. The buyer of the option has the right, but not the obligation to buy an agreed quantity of a particular commodity (called the underlier) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or “writer”) is obligated to sell the underlier should the buyer so decide to make the purchase. The buyer pays a fee (called a premium) for this right.
The buyer of a call option wants the price of the underlier to rise in the future; the seller either expects that it will not, or is willing to give up some of the upside (profit) from a price rise in return for the premium (paid immediately) and retaining the opportunity to make a gain up to the strike price (see below for examples).
Call options are most profitable for the buyer when the underlier is moving up, making it’s price closer to the strike price. When the price of the underlier surpasses the strike price, the option is said to be “in the money”.
The initial transaction in this context (buying/selling a call option) is not the supplying of a physical or financial asset (the underlier). Rather it is the granting of the right to buy the underlying asset, in exchange for a fee - the option price or premium.
A put option is a financial contract between two parties, the buyer and the writer (seller). The put allows the buyer the right but not the obligation to sell a commodity or financial instrument (underlier) to the writer (seller) of the option at a certain time for a certain price (the strike price). The writer (seller) has the obligation to purchase the underlying asset at that strike price, if the buyer exercises the option.
Note that the writer of the option is agreeing to buy the underlying asset if the buyer exercises the option. In exchange for having this option, the buyer pays the writer (seller) a fee (the premium). (Note: Although option writers are frequently referred to as sellers, because they initially sell the option that they create, thus taking a long position in the option, they are not the only sellers. An option holder can also sell his short position in the option. However, the difference between the two sellers is that the option writer takes on the legal obligation to buy the underlying asset at the strike price, whereas the option holder is merely selling his short position, and is not contractually obligated by the sold option.)
The put buyer either believes it’s likely the price of the underlier will fall by the exercise date, or hopes to protect a long position in the asset. The advantage of buying a put over shorting the asset is that the risk is limited to the premium. The put writer does not believe the price of the underlier is likely to fall. The writer sells the put to collect the premium.
LEAPS
Given the plethora of opportunities that options allow, it is also important to know that there are options available which can be used to implement longer-term strategies.
These are called LEAPS (Long Term Equity Anticipation Securities) and are yet another alternative that options offer to investors.
LEAPS are publicly traded options contracts with expiration dates that are longer than one year. Structurally, LEAPS are no different than short-term options, but the later expiration dates offer the opportunity for long-term investors to gain exposure to prolonged price changes without needing to use a combination of shorter-term option contracts. The premiums for LEAPs are higher than for standard options in the same stock because the increased expiration date gives the underlying asset more time to make a substantial move and for the investor to make a healthy profit.
LEAPS are an excellent way for a longer-term trader to gain exposure to a prolonged trend in a given security without having to roll several short-term contracts together. The ability to buy a call/put option that expires one or two years in the future is very alluring because it gives the holder exposure to the long-term price movement without the need to invest the larger amount of capital that would be required to own the underlying asset outright. These long-term options can be purchased not only for individual stocks, but also for equity indexes.
www.StockOptionReport.com
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January 15th, 2008 by admin
As you know, when it concerns investing money in the stock market, or any other sort of exchange, there’s always going to be a reasonable measure of risk involved. You could make an immense amount of money and retire, or you could turn a loss and lose your shirt with a poor decision.
In the long run, you better determine precisely how and what you would like to trade and when you want to do it, as it’s your income that’s laying on the line. Although I can’t tell you how to trade in such a short article, and wouldn’t even set about to do so, I can share with you a couple of tips that I use and apply in my stock options trading. If you choose to use them, you do so at your own risk. You are able to adjust them as you wish, or dismiss them altogether, that’s up to you.
The first thing you had better do if you are thinking of getting into options trading is to become acquainted with all of the language, and just exactly what is what. You need to learn just what stock options are, and the difference between call options and put options. You need to become acquainted with option premiums, and their outcomes on the costs of your trades. If you don’t understand these basic principles, you will never be able to become a successful options trader. There are tons of information about these subjects available on the web, just do a search on “online option trading” or “option trading schools” and you’ll see tons or results. You may also want to join an option trading forum or newsgroup as well, so that you can learn from other options traders. This is often one of the better techniques to learn something new, by having a mentor who has already made it through the mistakes. You can also join option trading courses or seminars, or buy e-books on the internet with respect to this. Whatever you do, make sure you educate yourself before heading into the markets.
Once you’ve taken the time to become comfortable with the points of options trading, the following thing you need to do is work out just how much disposable cash you have to trade with Article on how much capital to invest. If you don’t know this, you can’t even start to trade. Don’t consider putting any money in this that you cannot afford to lose, as there are no guarantees in the stock market, no matter how skilled you may be. If you’re somebody who pays their bills and has little to no cash leftover, then you shouldn’t even try to invest until your financial state of affairs improves, but again, that is of our own choice. Just know that if you invest or trade with money that you can’t afford to lose, and you do lose it, it can be very hard to get caught back up again.
When you first begin with options trading, start by “paper trading”. After you have acquired some confidence and your paper trades are doing well, then possibly you are able to jump into real trading. Always remember to try and downplay your risk, so when you first start you should try to trade options that have lower option premiums (priced at very low rates), so that you don’t bear a lot of risk, and don’t stand to lose a lot of money if you make a error. Many starting out options traders will invest in many small stock counters, so that they have a wide spread, which gives them better financial trade protection. It unquestionably isn’t a good idea to invest everything you have in one option, at least not for most novice traders.
Set yourself a time frame, and then appraise your trading at the end of that time to see how you have done. Most fresh traders begin with 6 months, which gives them time to create an option trading system, and fine-tune it so it works for them. If you feel that you have become a good trader and have made more cash than you have lost, then by all means, continue if you wish, and maybe even move on to larger trades. If you have made bad selections, and have finished up in the minus side, then you might want to go back to paper trading or spend some more time learning from other people, and try again in the future, or at least stay with small trades until you hone your skills.
In the end, you’ll have to find the best method that works for you. Just be sure that you don’t invest money that you can’t lose, take time to learn as much as you can about options trading, and then just give yourself time to become comfortable as a trader.
Brian makes his living as a full time trader and coach, if you enjoyed the article, be sure to get your FREE report. Find out more about Online Option Trading Stock Option Trading Are You Committing Trading Suicide? Learn How I Make 100% Returns annually! Get “47 Tips To Guarantee Trading Success” Totally FREE At http://www.elitemarketeer.com
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