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Leverage
to Increase Share Returns
How to Avoid Margin Calls
Using Option Strategies
SEMINAR- There will be a seminar on the following
subject area here in our Sydney Office at 20 Bond Strret
on Wednesday 15th October. To register call 02 82324225
It is often the case that leverage is a double edged
sword. On the one side extending gains in the market
when the market rises but on the other side increasing
the fall in equity when the market falls. The last three
years have seen falls in the market which even
conservatively geared (gearing relates to the ratio of
borrowing to equity, so a gearing of 0.5 would indicate
50% equity, 50% borrowing) portfolios have seen margin
calls. Of course times change and the market is
currently seeing a strong rally based on an economic
recovery in the US, Europe, and Asia.
However, shocks can occur, and one day a boggy man will
come to put an end to the seemingly continuous rises, it
may be interest rate fears, it may be worse than
expected economic figures, whatever the reason the
market place is volatile. With a long term view, say 5
years we can ride the ups and downs, but if we are
leveraged into the market we may find ourselves having
to produce more cash, or worse, selling stock at market
lows to cover margin calls. However, here at Macquarire
Bank the guys in Equity Markets have produced one of the
most flexible capital protected leveraged portfolio
management system around, allowing 100% borrowing for
purchase of shares with a hedge in place to protect
against adverse price action below the purchase price.
Its called the Flexible Trading facility (FTF), and it
truly is flexible, for my clients I can buy long dated
puts to hedge the position, then sell calls, (covered
call strategy) for shorter dated calls. Or just take
profits and sell the put for its residual value. The
important thing is the flexibility is there, and unlike
margin lending there is no margin maintenance.
I have drawn out some examples of the Option strategies
you might utilise within the FTF below. The FTF
prospectus are available from myself, to get yours just
give me a call on 02 8232 3931.
Richard Pritchard
PROTECTED COVERED CALL STRATEGY
Lets consider how to protect the capital value of our
shares and still attempt to generate income through
dividends and Covered Call Writing.
This strategy is merely an extension of the covered call
strategy. However in this instance you will pay premium
to buy a protective put for your shares as well as sell
calls. But the key is to take advantage of the pricing
differences between short dated and long dated options.
The above diagram depicts the purchase of 1000 NCP
shares @ $12.00 and a protective put with corresponding
$12.00 strike, thus making the maximum loss from the
strategy at or before the expiry of the option to be
only the cost (60c) of the bought put. But allows for
unlimited share price appreciation.
Step 2 – Now we add the Sale of a Covered Call
In Step 2 we have sold a Call with a strike of $12.50 on
our NCP shares. This has the effect of reducing our
maximum loss and caps our return. The sold call has one
month to expiry whereas the bought put has 3 months
duration thus allowing sale of further calls after the
expiry at end of October of the existing call. Puts can
be bought for a year or more if desired.
Step 3 – Time Decay of a Three Month Bought Put
Option Combined with Three Monthly Sold Calls
As a general guide, an option will lose 1/3 of its time
value during the first half of its life and 2/3 during
the second half. All things being equal. 3 sold monthly
calls will produce greater returns to the seller than
the cost of 1 bought 3 month put.
The above diagram attempts to explain the relationship
between time and premium i.e. the fact that longer dated
options do not increase in value in direct proportion to
the time increase to their expiry. And the time decay
effect of near dated options in relation to longer dated
options, regardless wether they are Puts or Calls.
Another Example this time factoring in the payment of an
upcoming dividend at the time the strategy was put in
place
Profit and Loss Diagram for CBA Buy and Buy November
Put at the Money-Taken out in Mid August
Here the purchase of the Put is almost completely offset
by the dividend payment allowing for the sale of calls
which will produce an immediate return for the strategy.
For more information on these and other Option
Strategies talk to an Accredited Derivatives Adviser on
1800 815 099. Or contact myself on 02 8232 3931- I will
be more than happy to discuss your current investments
and future investment needs.
Disclaimer: The
information contained in this note is confidential. If
you are not the intended recipient, you may not disclose
or use the information in this note in any way.
Macquarie Equities has made every effort to ensure the
information is accurate, however its accuracy,
reliability or completeness is not guaranteed. Email
transmission cannot be guaranteed to be secure or
error-free as information may be intercepted, corrupted,
lost, destroyed, arrive late or incomplete, or contain
viruses. Therefore, we do not accept any liability, for
any error or omission in this email or for any resulting
loss or damage suffered as a result of email
transmission. Opinions expressed may change without
notice. No part of this email is to be construed as a
solicitation to buy or sell any security. Macquarie
Equities, in preparing this email, did not take into
account the investment objectives, financial situation
and particular needs of the investor. Before making an
investment decision on the basis of this advice, the
investor or prospective investor needs to consider, with
or without the assistance of a securities adviser,
whether the advice is appropriate in light of their
particular investment needs, objectives and financial
circumstances. International investors are reminded of
the risks inherent in international investments, such as
currency fluctuations and international stock market or
economic conditions, which may adversely affect the
value of the investment.
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