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Option Trading Background  

31 March 2008

While Option Trading may appear to be complicated it can be quite simple. It is a matter of understanding the fundamentals.  Option Trading plays an important role in modern financial markets. Originating in 1973 in Chicago, Exchange Traded Options developed rapidly in both turnover and sophistication. Record turnovers have occurred since the 1987 stock market crash.

The advantages of Option Trading has increasingly been realized by direct share investors.

Option Trading can be used:
• to increase the return on a share portfolio,
• to hedge against potential losses, i.e. to act as insurance,
• for trading purposes.

Option Trading can be a versatile business alternative.

Option Trading can provide protection for direct share portfolios.

Today index options are very actively traded instruments and it is this area of the market that the Optioneer Option Trading Program is involved. Index options are similar to listed share options however there are important differences between the two. The main difference being the ability to profit from - or hedge against - over-all stock market volatility, as opposed to changes in individual share prices.

One of the primary attractions of Option Trading the indices is the simplicity. You may have a definite opinion about the trend of the market or specific industry groups, but feel less sure about the direction of individual shares. Option Trading the indices can be used to acton such opinions without the risks associated with choosing specific shares. Option Trading the indices can also be a valuable hedging tool used in conjunction with diversified stock positions, because they allow for the separation of two basic components of common stock, that is, market risk and business risk.

Market risk is related to interest rate changes, inflation levels and other economic or political developments that influence the general market trend. Business risk is related to specific company and industry factors, such as quality management, earnings prospects, competition and labour disputes, that may affect a particular corporation.

Business risk can be significantly reduced through reasonable portfolio diversification. As such, market risk is usually the primary risk in owning diversified stock positions. Option Trading the indices provides a means by which market risk can be minimized by hedging
share portfolios against adverse market swings.

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