How to use exchange-traded options in your SMSF.
The sharemarket offers self-managed (or DIY) superannuation fund investors various ways of making money. For example, shares can be bought with the expectation of a price increase that will deliver a capital profit.
For a DIY super investor, the concessional tax rate that super attracts will lead to either 85 per cent of the gain after tax added to the fund’s wealth or 90 per cent if the shares were owned for more than 12 months before being sold.
Even better is a 100 per cent profit gain if the shares are sold after the fund has begun to pay all its member super pensions.
Shares can also pay dividends that are enhanced by tax credits available under the dividend imputation system. For a DIY fund with its 15 per cent or zero per cent tax rate (depending on whether it has started paying pensions to its members) a share paying a 5 per cent dividend can sharpen income by an extra 1 to 2 per cent thanks to the dividend tax credit.
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More sophisticated investors can also gain either extra income or a combination of extra income plus a capital profit by offering to sell shares they own to other investors for a predetermined price. Such arrangements are more sophisticated because they require a detailed understanding of investments known as exchange-traded options.
Author and options adviser Wai-Yee Chen of broker RBS Morgans, says an exchange-traded option (ETO) is actually a financial contract between two investors that is organised and monitored by a stock exchange such as the Australian Securities Exchange.
The contract is a legal arrangement where one investor agrees to sell shares they own in 100 share lots to the other for a predetermined price. This offer to sell lasts for a certain period of time that can be a year or more but is generally three to six months.
The contract to sell involves not only a predetermined sale price but also an extra cost added by the seller for giving the buyer the right to acquire the shares. This extra cost is described as an option premium.
Exercising is a choice.
A special aspect of ETOs is that the option seller must deliver their shares at the predetermined price if requested by the buyer during the contract period. The buyer has a choice of not exercising this right if the predetermined price they must pay before the option expires is greater than the market cost.
An option buyer in this instance can either let the option lapse or sell the right through the Australian Stock Exchange.
While the contract is in play, options have a tradeable value that is quoted on the ASX, which may or may not be worth more than what the buyer paid.
As far as the tax treatment of various aspects of options investing is concerned, this is topical as a result of the government’s plans to restrict how trading gains and losses should be treated. Under a revised tax regime that will apply from July 1, 2012, any losses on option trades can only be offset against capital gains.
This contrasts with widely held trading rules, where certain investors have been able to offset losses against current fund income such as interest income and dividend income.
A reader writes: “I read your recent report about the government changing the trading rules for DIY super (Portfolio, February 15, 2012). How will it affect the use of exchange-traded options as an income strategy?"
DIY fund investors can still use ETOs as part of an income strategy, says lawyer Bill Fuggle, a derivatives specialist with Baker & McKenzie.
But if they have been treating them as short-term trading investments in order to be able to claim any losses against general fund income, this won’t be available to them. Many experts believe these rules already apply to DIY funds.
This means if investors have no capital gains because they have not sold any investments at a capital profit during the financial year, the best they can do with option-related losses in a DIY fund is accumulate them for offset against gains in a future financial year.
Losses on options trading generally occur when option buyers sell out of their position at a price below the premium they paid.
While such profits have been treated as revenue by some investors, the treatment for a DIY fund investor will need to be along capital profit lines.
This means no immediate deduction for the cost of the option. Instead the option premium cost can only be added to the cost of the shares establishing a higher cost price in the capital gains calculations that apply when the shares are sold.
As far as the tax treatment of a profit made by option sellers who make extra income by offering investors the right to buy their shares, if the option is not exercised the premium received by the DIY fund is taxed as capital income.
If the shares are delivered as a result of the option’s transaction, the option premium income is added to the sale price of the shares.

Option trading smsf

For education on trading options, the best place to begin is with the market operator itself, The Australian Securities Exchange (ASX). The ASX have created a number of truly excellent interactive online classes, that have been structured to cover all aspects of the options market and allow you to progress through all topics at your own pace, or select a particular topic of interest.
For your convenience, and with the kind permission of the ASX, we have listed these online classes below, and have provided the live links to each one. Simply click on the title of interest, and your away. This content was created and is owned by the ASX.
1. Introduction to options.
An introduction to the basics of option trading. Why trade options? What are options, and who uses them? This course goes through the basic features of options, and explains how they differ from shares.
Estimated time to complete: 20mins .
2. What are options?
A more detailed look at what is in an option. This course explains the difference between call and put options, and discusses the main features of options traded on ASX, including exercise price, expiry, and exercise style.
Estimated time to complete: 20mins .
3. Option pricing.
How much is an option worth? This course looks at the influences on an option’s price. We explain the difference between intrinsic value and time value, and discuss the influence of variables such as volatility and time to expiry. We also look at the central importance of time decay in option trading.
Estimated time to complete: 20mins .
4. Choosing the right option strategy.
A basic guide to the things you need to think about when developing your option strategies. This course discusses some of the differences in approach between share investing and option trading. We explain how you can develop more effective strategies by taking into account volatility and time as well as price movements.
Estimated time to complete: 20mins .
5. Profit from a rising share price.
A look at how you can use options to trade your view that the market will rise. The bought call gives you leveraged exposure to a share price rise, and enables you to lock in the maximum purchase price for shares. This course discusses potential profits and losses, explains how to choose between the different calls on offer, and looks at your choices once you have bought your call.
Estimated time to complete: 20mins .
6. Profit from a falling share price.
How can you make money when you think share prices will fall? This course explains how put options give you the possibility to profit on the way down. We look at the risks and rewards of the bought put, and explain how to choose between the available options.
Estimated time to complete: 20mins .
7. Protect your shares.
Using options to protect your shares. Put options enable you to protect your shares from a fall in value – without having to sell them. This course explains how you can lock in a minimum sale price for your shares. We explain the benefits and costs of the protective put, and how to put the strategy in place.
Estimated time to complete: 20mins .
8. Earn income from your shares.
Shares generally produce little value in flat markets. This course explains how you can write call options to work your portfolio harder. Writing covered calls generates income in the form of option premiums and can be a profitable strategy in neutral markets.
Estimated time to complete: 20mins .
9. Index options.
Index options allow you to trade the whole market in one transaction. ASX offers options over three share price indices, giving you broad exposure in one trade. This course explains how you can use index options to get leveraged exposure to a rising or falling market, or to protect a diversified portfolio from a fall in value.
Estimated time to complete: 20mins .
10. How options are traded.
The mechanics of trading options. This course explains how the options market works. We look at how options are traded, cleared and settled, and point out the differences from, and similarities to, share investing. We discuss the role of market makers, explain the process of exercising an option, and give a few pointers on finding a broker.
Estimated time to complete: 20mins .
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SMSFs: Purchasing options is OK, and even sometimes CFDs.
Q: Can a SMSF buy/sell call/put options? I understand that CFDs are not permitted because it breaches the charge over asset regulation. However, is that true that options are derivatives and in giving shares as a collateral (when writing options) to the Options Clearing House, it will be treated differently (an exemption) as long as the SMSF has a derivatives risk management statement?
A: Before I answer your question about options, I need to clarify your comments about contracts for difference (CFD). In certain circumstances, the Australian Tax Office has indicated that CFDs are allowable investments for self-managed super funds (SMSFs), provided that cash is used as collateral for any margin payments on the contract, rather than using fund assets as collateral. Now, in my view, cash is a fund asset, and I’m surprised that the ATO has taken this view on CFDs but there you have it, although I would be closely following the ATO’s views if anyone is considering using CFDs within his or her SMSF.
In response to your question on options: Derivatives, such as options, are allowable investments for a SMSF, subject to certain conditions, including:
ensuring that the fund’s investment strategy (and trust deed) permits the SMSF to purchase options and the fund has a derivative risk statement, that is a statement that explains the SMSF’s risk management policies when using derivatives.
For the most part, options are used as a hedging tool to minimise the volatility in an investment portfolio, although some investors use options as a pure trading tool for profit.
Any SMSF trustee considering using options within a SMSF portfolio would be wise to confirm the use of such instruments with the ATO and/or with the fund’s adviser.
Note: Anyone considering derivatives within a super fund should also read Regulation 13.15A of the Superannuation Industry (Supervision) Regulations 1994, for some background on the use of collateral and derivatives.
What do the regulators say about CFDs?
ATO: The ATO says: “Be very careful when entering into contracts for these products that they do not allow a charge over a fund asset to occur, for instance where fund assets are deposited with the provider for margin calls.” You can read more about the ATO’s view on SMSFs and CFDs, by checking out the following ATO interpretive decisions:
ATO ID 2007/56. Superannuation Self Managed Superannuation Funds: contracts for differences (CFDs) – no fund assets deposited with CFD provider ATO ID 2007/57. Superannuation Self Managed Superannuation Funds: contracts for differences (CFDs) – fund assets deposited with CFD provider – charge over fund assets.
ASIC: The Australian Securities & Investments Commission states that CFDs are not a simple product. Trading CFDs is complex for several reasons:
CFDs might seem similar to mainstream investments such as shares, but they are very different. CFDs are not standardised and every CFD provider has their own terms and conditions. It is very hard to assess the counterparty risks involved in trading with any CFD provider. Leverage means small market movements can have a big impact on the success of your trades. CFDs are dependent on conditions in the market for the underlying asset, even though you are not actually trading the underlying asset.”
ASIC also warns investors that as well as understanding how CFDs work, you also need a good understanding of the risks of trading CFDs. ASIC has published a guide to CFDs explaining the pros and cons and how the CFD markets operate.
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Equity Options for SMSFs.
As you approach retirement it's prudent that you consider reducing your exposure to riskier assets like equities and increase exposure in safer assets like cash/bonds. However with current interest rates and the benefits franking credits provide via shares it is something that is seldom done.
Overweight holdings in shares expose your retirement savings to market corrections, a lesson learned the hard way for many during the GFC.
There is a valid alternative that allows you to continue to recieve franking credits and benefit from share price appreciation but protects your portfolio from large market corrections.
Purchasing protection from the options market can help!
The chart above shows an increasing share market until a market crash. Purchasing index put options returns cash to a well-diversified portfolio to help offset the decline in share prices whilst allowing you the continued benefit of share ownership (dividends, franking credits, etc.)
Implementing the Strategy.
Like an insurance policy there are a number of factors that influence the premium you pay for protection:
Portfolio Value Excess (Protection level) Length of Protection Market Risk.
The greater the level of excess (or protection level below the prevailing market) you are willing to accept the lower your premium will be. Obviously the longer the time frame the higher your protection cost will be. Finally the more risk or volatility in the market the higher premiums will be.
The following table helps identify the approximate percentage costs of insuring a well-diversified portfolio with index put options. Note: The table assumes a market volatility level of 13% and S&P/ASX 200 Index Value of 5250.
How many options to buy?
Once you have determined the protection level and timeframe that suits your needs the final step before placing your options order with your broker is to determine how many options are need to protect your portfolio.
ASX index option contracts are worth $10 per point if the protection level you choose is 5,000 points then 1 contract is worth $50,000 if your equity portfolio is worth around $500,000 then you would purchase 10 index options. $350,000 = 7; $1,000,000 = 100 etc.
ASX's portfolio protection calculator will help determine how many contracts to buy and at which exercise level.
What's the end result?
For every point the index falls below 5,000 points, when your options contract expires, you will recieve $10. The following table shows as the market falls losses are partially offset by cash you recieve from the options market. Whilst as the market rises you still continue to benefit from share price rises, albeit less the premium paid for protection.
Assume Index 5250 - 6 month 5% excess option bought. Portfolio Value = $525,000.
Where to from here?
ASX has a range of resources to help you better understand buying portfolio protection.
Finally you will need to find a broker to execute options through. Ask your broker or your adviser about options or use our free tool to find a broker.
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