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Investors tend to buy or sell option, e.g. call / put option, to adopt short term trading strategy and generate profits in Singapore. Beginners could be confused especially if they’re not familiar with why, how and when to trade options.
But, patience is a virtue – not just in our personal life, but also in our investment journey as well. By adopting a long-term investing strategy, investors who patiently hold a basket of strong stocks and/or ETFs can ride out market ups and downs in the short term.
At the same time, just because we see value in a long-term investment approach doesn’t mean that shorter-term trading tools are to be avoided like the plague. In fact, with the rising popularity and easier access to options trading, long-term investors could boost their investment returns, both in the short-term and the long-term.
Before we go about trying to buy or sell options, we need to have a good understanding of how they work. There are two main types of options that we can trade – a call option or a put option – and we can also choose to buy or sell either type of option. In this article, we’ll explain 4 important option trading strategies to let you know more about:
- When to buy call option?
- When to sell call option?
- When to buy put option?
- When to sell put option?
Finally, we’ll share how to buy and sell options in a cost-effective way in Singapore.
Read Also: Guide To How Singapore Investors Can Start Trading US Stocks With Little Money
What Is A Call Option?
When we buy a call option, we have the right, but not the obligation, to purchase an underlying asset at a specified strike price, before an expiration date. For this right to buy the underlying asset, we have to pay a premium.
At the end of the expiration date, if the stock price is above the strike price, we are “in the money”. This means we can purchase the stocks we want to buy at a lower price than what it is currently trading at – giving us a profit.
For example, if the current price of a stock is $100, the strike price of a call option could be $110. If the share price increases to $120, we can exercise the call option at any point before the expiration date, giving us an immediate profit of $10 for each share purchase.
We can also sell a call option, and the reverse becomes true when we do this. This is because someone else has bought the right to purchase the stocks from us at the strike price and we have the obligation to fulfil the order. By giving them this right, we receive an upfront premium. Ultimately, once the stock price is above the strike price, we are “out of the money” – i.e. we are losing money.
What Is A Put Option?
Put options are the opposite of call options. When we buy a put option, we have the right, but not the obligation, to sell an underlying asset at a specified strike price, before an expiration. For this right to sell the underlying asset, we also have to pay a premium.
If the stock price is below the strike price at the end of the expiration date, we are “in the money”. This means we can sell our underlying stocks at a higher price than what it is currently trading at – giving us a profit.
For example, if the current price of a share is $100, the strike price of a put option could be $90. If the share price drops to $85, we can still sell our shares at a price of $90, $5 more than the current market price.
Similarly, if we sell a put option, someone has purchased the right to sell us the stock at the strike price. We also receive the premium upfront in this instance. However, it also means that if the stock price dips under the strike price, we are obligated to buy the stocks at the higher strike price – and as such, we will be losing money.
Should Beginner Investors Even Consider Trading Options?
Rightly so, options are typically looked at as shorter-term trading instruments. However, this does not mean that long-term investors cannot benefit from trading them. Before buying or selling options to improve our investment returns, we need to also know the strategies to benefit from buying and/or selling options.
Option Trading Strategy 1 (Buy Put): Hedging Our Portfolio Downside
As long-term investors, we may be less concerned with timing the market and simply want to regularly invest. At the same time, we obviously don’t want to invest right before a market crash either – especially when markets are volatile.
Options can reduce such downside risks. For example, let’s say we purchase 100 Apple shares at US$175 a piece today. But, we are afraid that the market may tank. Afterall, there’s widespread conversations around inflation worries, the trade war between US and China, and that tech stocks are overvalued.
Along with our investment, we can also buy a put option at US$157.50 (effectively limiting our downside to a maximum loss of about 10%). This allows us to enjoy the upside, while reducing the risk of poor or unlucky market timing in the short-term.
To make use of this hedging strategy, we have to pay a small premium. Using a brokerage platform like Futu SG via the trading platform, moomoo, we can check out the various strike prices and the corresponding premium that we have to pay for the put option.
At the point of writing, we can see that the cost of buying a put option for 100 Apple shares (currently, Apple shares are trading at $176.280) at a strike price of US$157.50, that expires in approximately 10 days, is US$0.23 (note, we use the last done price). This means a put option for 100 Apple shares at a strike price of US$157.500 will cost us US$23.
If Apple stocks plunge about 20% to US$140 in the next two weeks, we can sell our Apple shares at the strike price of US$157.50 – limiting our downside. If our fears are unfounded and Apple shares soar to US$200 in the next ten days, our gain would outpace the premium we paid on the put option.
As we can already deduce, this strategy is useful during periods of heightened uncertainties. We can choose to buy a put option on our entire shareholdings, effectively locking in the gains without making any actual transactions.
Option Trading Strategy 2 (Sell Put): Selling Puts Options On Stocks We Already Want To Buy
As a long-term investor, we may want to purchase stocks or ETFs on a regular basis. We can utilise put options to boost our investment returns.
For example, if we want to purchase 100 Apple shares each quarter. We can simply sell a put option that is slightly lower than the existing price during the quarter. The benefit is that we will receive a small upfront premium, while giving us the right to purchase Apple shares at a slightly lower price than if we had bought them today.
Through FUTU SG, we can choose to sell a put option for 100 Apple stocks at a strike price of US$170. When we do this, we can earn an upfront premium of US$151 (1 contract = 100 shares)
This works out because we were already willing to buy the Apple stocks at the current share price. Even if we don’t immediately buy the Apple shares, we can just continue selling puts for the entire quarter until the strike price is hit and we are obligated to make the purchase. In the interim, we earn a small premium each time we sell a put option.
If the strike price is not hit during the entire quarter, we can simply purchase the Apple stocks at any price it is trading at the end of the quarter. The drawback of employing this strategy is that if prices rise by a great deal, and we end up paying more for our investment in Apple stocks.
Option Trading Strategy 3 (Buy Call): Replacing Part Of Our Portfolio With Options Instead
The third strategy we may utilise is to use options rather than buying the underlying stocks.
For example, we may think Apple’s stock price will rise. We can buy a call option on Apple stocks at US$177.50 by paying a premium of US$201 (expires in about 10 days) versus forking out US$17,500 to purchase 100 Apple shares.
If we’re wrong and Apple’s stock price dips, or do not go above the price level of US$177.50, we are not obligated to purchase any stocks. In this scenario, we will simply forfeit the US$201 premium for the call option.
However, if Apple’s stock price rises above $177.50 in the next two weeks, we can purchase the shares below its trading value.
As mentioned, a big part of the benefit is not having to fork out US$17,500 for 100 Apple shares today, while retaining the right to profit if we turn out to be correct in our investment thesis.
Option Trading Strategy 4 (Sell Call): Selling Covered Calls To Earn A Regular Premium
Using call options, we can effectively “rent out” stocks that we already own and get paid for it. This strategy is commonly referred to as selling covered calls.
Again, let’s say we purchase 100 Apple shares at US$175 today. We can immediately sell a covered call option – giving a buyer the right to purchase our Apple shares if it goes above the strike price. For example, we don’t believe Apple’s stock price will spike above 10% in the next 10 days. We can sell a covered call at a strike price of US$190 (approximately a 10% premium to today’s price), receiving US$42 in upfront premiums.
If Apple’s stock price remains below US$190 in the next two weeks, we will bank in the US$42. However, the obvious con is that Apple’s stocks may soar above US$190 in the next two weeks, and we will be obligated to sell our shares.
Read Also: Step-By-Step Guide To Opening A FUTU SG Securities Account With moomoo
A Low-Cost And User-Friendly Way To Start Buy And Selling Options in Singapore
Even if we are long-term buy-and-hold investors, there can be a place in our portfolio for options to reduce our investment risk during periods of great uncertainties as well as help us boost our overall returns.
To start building our long-term portfolio and incorporate options to boost our returns, we can rely on a low-cost and user-friendly MAS-regulated broker such as Futu SG via the trading platform, moomoo. With Futu SG, we get access to both stocks and options at a very competitive brokerage fee, starting from only US$1.99 for stocks, while the commissions for options are priced at US$0.95 per contract.
For investors new to moomoo, there is also a limited-time Christmas Bonus from now till 31 December 2021 where we can participate in moomoo daily Snatch ‘n’ Win (exclusive to new moo-ers who have made an initial deposit min SGD 2700). Snatch yourself a sure-win gift including iPhone 13, Airpods gen 3, Grab Vouchers and more.
What’s more is that we can also enjoy 180-days of commission-free stock trading – making it even more affordable to grow our long-term portfolio – and get free access to Level 2 data, enabling us to view market depth information – such as the buying and selling queue.
What all this means is that there’s no reason not to open a brokerage account with them today!
Photo by Patrick Weissenberger on Unsplash