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ASX200 Index Put Options

March 1st, 2007 at 03:47 am

Moom asked what date the ASX200 Put Options that I mentioned in my previous post expire - they are the 5500 options which expire on 20-Dec (XJOQT). I bought them on 9-Feb at 158.00, so the 3 contracts (each contract is for 1,000 options) cost $4,795.77 (including brokerage).

For interest I looked up the ASX200 index (XJO) closing value and plotted it against the "market price" for the XJOQT options that Comsec has been emailing me each day since I opened my position. As you can see, the option price has a negative correlation to the ASX200 Index, but the correspondence isn't perfect as the market for the options is quite thin and the buy-sell spread is larger than you'd get trading stocks. As the Options don't expire until Dec-20 their current price is a combination of the strike price relative to the current Index value, and the "time value" of the option until expiry. At the moment it appears (from the graph of option price vs. index value) that each contract would be worth around $5,000 if the index dropped to the 5500 level (another 5.5% drop from current levels), but at the expiration date of 20-Dec the options would have no value above the 5500 level, and will be "cashed out" for $10 per 1 pt below 5500 on 20-Dec (if I hold them until expiry).

As my entire direct investment in the Australian stock market is around $600K each 1pt decline in the market costs me around $100. Therefore I'd have to be holding 10 of the Index Put Option contracts to be fully covered for losses below the contract strike price. With only 3 contracts I'd be making $30 profit on the contracts for each 1 pt decline to offset against the $100 loss on my stock holdings. As my stock portfolio is currently geared around 100% I'd need 5 contracts to make my portfolio losses match the actual % market decline below the 5500 level, and 10 contracts to be fully "insured" against any loss if the market drops below 5500 prior to Dec-20.

I'll buy another 5 or 7 contracts if the market resumes it's bull run and goes above the 6100-6200 level. Hopefully I can get fully "insured" against drops below the 5500 level for a total cost of around $10K (around 1.7% of my portfolio value, or around 3.3% of my equity). This would "cap" my exposure in a bear market to a maximum loss on my Australian stock portfolio to around $35K, or about 10% of my equity in AU stocks. I'd still retain my exposure to any upside if the market continues it's bull run. If the market gains another 10% by the second half of '07 (around the 6400-6500 level) I'll look to start selling off half my AU stock portfolio and use the proceeds to eliminate my gearing until the end of the next bear market is in sight (ie. All Ords back down to around the 4000 level).

Although this all smacks of an attempt to "time the market" I think it's prudent to make use of Put options when the market has gone up around 20% for each of the past three years, and to look at reducing my use of gearing when the market's p/e appears to be getting stretched at the end of an extended bull run.

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