Options Trading in Singapore: A beginner’s self-start guide.
Options trading has been gaining popularity. You might have even heard of Singapore investors dabbling in Options Trading and how these savvy investors are using it to maximise their returns.
p.s. this guide was first published in 2019 and has been updated on 3 Jan 2022.
Options Trading for Beginners.
This guide was created for beginners who want the fundamentals of options trading. I’ll explain how Options work. We’ll learn about options trading terms, types of options, the differences between intrinsic and extrinsic value and more.
Before we proceed, I would like to say that options can be a dangerous tool. It remains a double-edged sword in the investor’s toolbox and many would regard it as a risky endeavour.
While it can bring about huge profits, unprecedented losses can also happen if you do not know what you are doing. It is a complicated instrument where, unlike stocks, prices are determined by several factors that can easily swing from one end to the other. Thus, you should avoid using it if you do not understand its mechanics well.
I’ll do my best to present the fundamentals that’ll help you get started in the right (and safer) direction. So, if you are planning to trade options in Singapore but don’t know where or how to get started, then you are just in the right place.
But before anything else, let us first define what options are:
What are Options?
An option is a contract between a buyer and a seller which gives the buyer the right to buy (call options) or to sell (put options) the underlying assets at a specific price on or before a certain date to the seller.
For a complete, academic definition, we refer to Investopedia which states:
“a financial derivative that represents a contract sold by one party (the option writer) to another party (the option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price during a certain period of time or on a specific date.”
Options are a powerful tool that can be used by investors as a hedge from market crashes, while also generating recurring income.
On the other hand, it can also be used by traders to magnify their returns and generate profit in any market condition.
What is Options Trading?
Options Trading is the process of trading options. Investors use options trading for various purposes such as earning extra income on their stock positions, earning extra income while waiting for their desired stock to drop to a certain price, and many more.
P.S. I’ll share beginner options trading strategies that you can learn and execute in another article. But first, let’s get our fundamentals right.
How is Options Trading different from Stocks Trading?
When you trade stocks, you’re actually buying and owning the stock, which is a financial asset. As a shareholder, you gain access to shareholder meetings, dividend payouts and more.
However, when you trade options, you’re dealing with a derivative instrument that gives you the right to buy or sell an underlying asset at pre-determined prices. You don’t actually own the underlying asset.
Option Trading terms you must know.
Before we proceed, here’re some terms you should know:
Strike Price: price at which a put or call option can be exercised. Expiry Date: date on which your option will expire. Premium: current market price of the option contract Call Option: option that gives the buyer the right to buy Buy Option: option that gives the buyer the right to sell In the Money (ITM) : refers to an option that possesses intrinsic value Out of the Money (OTM): refers to an option that only contains extrinsic value At the Money (ATM): when an option’s strike price is identical to the current market price of the underlying security.
Overwhelmed? Don’t worry, we’ll go through the concepts with a (hopefully) clear case study!
Two types of Options.
At its core, there are two types of options, Call and Put options.
However, you can either buy or sell them. I’ll explain these four scenarios in this section, using Microsoft as an example.
For this case study, let’s assume that Microsoft is currently trading at $260.
1) Call Options.
How Call Options work (as a Buyer)
A call option gives a buyer the right to buy 100 shares of a stock at a specific price on or before an expiration date from a seller.
Here’s an example of how a call option works.
Let’s assume that Microsoft is currently trading at $260. If I believe that its share price will go up within the next 2 months, I can buy a call option expiring two months for now.
More specifically, I would buy a call option with 60 days to expiry, at a strike price of $270 (the price I believe Microsoft would hit). Doing so I would pay a premium of $430 for each contract (do note that each contract represents 100 shares) .
If Microsoft remains below my strike price of $270 , I will lose my premium. There is no point in converting my options contracts to shares since I can get the shares from the stock market at a price cheaper than $270.
However, if Microsoft share price were to shoot up beyond $270 plus my premiums paid , my options would become profitable. I can exercise the options to convert them into shares.
That said, most Options traders usually sell their options for a profit, rather than converting them into shares.
As a buyer in this Call Options scenario, you are exposed to:
Max loss = $430 + commission fees Breakeven point = $270 + $4.30 = $274.30 Profit if Microsoft hits $280 = ($280-$270) X 100 shares – $430 premium = $570 Max profit = Unlimited ( assuming Microsoft’s price has the ability to go to the moon )
How Call Options work ( as a Seller )
Selling a call option allows you to collect the premium from the buyer .
If it does not reach the intent strike price, the seller would be able to keep this premium. However, if the stock shoots up in value, the option seller would have to sell its shares to the buyer at a loss. (If options are exercised.)
Using the same scenario as above, here’s how it would play out if you are the seller instead of the buyer of call options. As a seller, you believe that Microsoft would not increase to $270 within the next two months so you are more than willing to sell the call options.
More specifically, you would sell a call option at a strike price of $270 with 60 days to expiry . By doing so, you collect $430 for each contract (noting that each contract represents 100 shares).
If Microsoft indeed stayed below $270 , you would get to keep the premium given to you at the start since it is unlikely the buyer would exercise it.
However, if Microsoft share price were to shoot up beyond $270 plus premiums paid , your options would now be making a loss and the buyer could choose to buy your shares over at $270. Even if the current price for Microsoft is $280.
As a seller in this Call Options scenario, you are exposed to:
Max loss = Unlimited Breakeven point = $270 + $4.30 = $274.30 Max profit = $430 – commission fees.
This is the main reason why you do not want to sell naked call options. A jump in share price would result in a huge loss!
How Put Options work (as a Buyer)
A put option gives a buyer the right to sell 100 shares of a stock at a specific price on or before an expiration date from a seller.
Now here’s an example of how a put option works, assuming once again that Microsoft is trading at $260.
If I believe that Microsoft share price would drop in the next two months, I can choose to buy a put option expiring two months for now.
More specifically, I would buy a put option with 60 days to expiry, at a strike price of $250 (the price I believe Microsoft would at least drop to). Doing so I would pay a premium of $655 for each contract (noting that each contract represents 100 shares).
If Microsoft remains above my strike price of $250 , I will lose my premium. There is no point in selling my shares to the options seller, since I can sell them on the market for a price higher than $250.
However, if Microsoft share price were to drop beyond $250 minus my premium paid , my options would become profitable. I can exercise them to sell my shares at a higher price than what is trading on the market.
Note: most Options traders usually sell their options for a profit rather than converting them into shares.
As a buyer in this Put Options scenario, you are exposed to:
Max loss = $655 + commission fees Breakeven point = $250 – $6.55 = S243.45 Profit if Microsoft drops to $240 = ($250-$240) X 100 shares – $655 premium = $345 Max profit = till Microsoft drops to $0, which is almost impossible.
How Put Options work (as a Seller)
Selling a put option allows the seller to collect the premium from the buyer .
If it does not reach the intended strike price, the seller would be able to keep the premium. However, if the stock drops in value, the option seller would have to buy shares from the options buyer at a loss. (If options are exercised.)
Likewise, let’s use the same scenario as above, from the POV of the seller.
As a seller, you believe that Microsoft would stay above $250 within the next two months so you sell the put option to the buyer above. More specifically, you sell a put option at a strike price of $250 with 60 days to expiry . By doing so, you collected $655 for each contract (noting that each contract represents 100 shares).
If Microsoft indeed stayed above $250 , you would get to keep the premium given to you at the start since it is unlikely the buyer would exercise it.
However, if Microsoft share price were to drop below $250 plus the premium paid , your options would now be making a loss and the buyer could choose to sell their shares to you at $250 per share. Even if the current price for Microsoft is lower than $250.
As a seller in this Put Options scenario, you are exposed to:
Max loss = till Microsoft drops to $0 Breakeven point = $250 – $6.55 = S243.45 Max profit = $655 – commission fees.
Similarly, you should not sell naked put options as a sudden drop in share price would result in a huge loss.
Well, the above is only one part of the options pricing mechanism.
It has only accounted for the intrinsic (inherent) value of the options while its extrinsic value has been excluded.
What is the “Extrinsic Value” of an Option?
Well, extrinsic value is the difference between the market price of the options and its intrinsic value. In other words, it is the ‘hope value’ – the hope that the options would reach the strike price.
This is determined by the time left till the option contact expires aka the ‘time value’ and its implied volatility aka the ‘ degree of price swings’ .
Time Value.
Usually an options contract with a longer time frame has a higher premium due to the higher probability that the strike price will be hit before expirations.
As a contract nears its expiry date, it starts to lose its time value as there is less time for the underlying stock to move in the desired direction.
Implied volatility.
When the underlying stock has higher implied volatility, it means that its price fluctuates substantially. This poses a greater risk to options sellers as stocks with higher implied volatility have a higher probability of hitting the strike price.
As such, stocks with higher implied volatility tends to have a higher extrinsic value and are traded at a higher premium.
At the end of the day, as an option reaches its expiry, the extrinsic value would drop to $0, leaving only the intrinsic value of the option, aka its true price.
What are Options Greeks?
All in all, intrinsic and extrinsic factors can be measured by four indicators, collectively are known as the “Options Greeks”:
Theta.
Theta measures the rate of time decay of an option contract.
As time passes, options start to lose their value, this decay tends to accelerate as the options near expiry as the probability of hitting the strike price is reduced.
By looking at the Theta of a particular options contract, we can determine the rate of this decay, which allows the seller and buyer to weigh the risk and reward of trading that contract.
For example, an option contract with a Theta of -1.5 is losing $1.50 in value each day.
Delta.
Delta measures the change in option premium as a result of the change in the prices of the underlying securities .
The Delta value can range from -1.00 to 0 for Put options and 0 to 1.00 for Call options. Put options have a negative relationship with the price of the underlying asset thus their delta are negative. Whereas Call options on the other hand, have a positive relationship with the price of the underlying asset.
If a call option has a Delta of 0.50, a $1 increase in the price of the underlying asset will result in a $0.50 increase in the options price. Conversely, if a put option has a Delta of -0.50, a $1 increase in the price of the underlying asset will result in a $0.50 decrease in the options price.
Note: In-the-money options (options at their intended strike price) tend to have a higher delta as compared to out of the money call options.
Delta is also commonly used to determine the probability of an option to expire in the money . As such, a call option will a Delta of 0.25 has roughly a 25% chance of being profitable.
Gamma.
The Delta of an option changes over time and this is measure by Gamma which measures the rate of change of Delta over time . (If you studied physics, Gamma is akin to acceleration while Delta is the velocity). Unlike Delta, Gamma remains constant and thus is useful to determine the stability of an option price .
Gamma is at its highest when the option is at the money. If an option has a Gamma value of 0.20, for every $1 increase in the underlying stock, a call option Delta would increase by 0.20 while a put option Delta would decrease by 0.20.
Another way to think of it is that, Delta measures the probability of the options being in the money while Gamma measures the stability of this probability over time.
Vega.
Vega measures an option’s sensitivity to implied volatility .
We have mentioned how the volatility of the underlying stock has a certain impact on the option price. Vega seeks to measure how much this price will increase or decrease, as a result of the change in the implied volatility of a stock.
In general, an option seller would benefit from a fall in implied volatility because, lower implied volatility means a lower probability of hitting the strike price, which is what an option seller wants to achieve. The reasoning is reversed for options buyers.
Now that we have that covered, let us now move on to the 5 things you need to know about trading options in Singapore:
5 Things to Know Before Trading Options in Singapore.
#1 Be Wary of Unregulated Online Trading Platforms.
Usually, newbies fall trap into signing up for Foreign Exchange or Forex trading seminars on unregulated online trading platforms. And it’s not your fault, especially with all the “get rich quick” advertisements and their claims of having 100% return trading options.
However, instead of believing such claims, you might want to take these as red flags ???.
Remember that the options trading world is very dynamic. Nothing can be set to stone. Those who claim to make 100% success with their returns are more often than not, exaggerating.
Trading with unregulated online platforms puts you out of the protection of laws and regulations made by the Monetary Authority of Singapore (MAS) to safeguard investors. Doing so will make you vulnerable to scams and put you in the position of being unable to resolve any grievances.
On the other hand, regulated financial institutions are subjected to MAS’ regulations that aim to protect investors’ money and assets. Furthermore, these institutions are required to maintain segregated customers accounts, controls, and records to safeguard your privacy and personal information.
As an investor, you are strongly encouraged to only deal with financial institutions regulated by MAS. You can refer to MAS’ website to double-check if your broker is regulated by MAS.
#2 Be Wary of Binary Options.
In line with the first point, unregulated online trading platforms tend to offer another form of investment instrument that you must also be wary of, binary options. A binary option is a type of option that references an underlying instrument.
This instrument can be in a form of asset classes like stocks, commodities, currencies, and interest rates.
The returns of this type of Options are dependent on the instrument. If the threshold amount is exceeded, then there will be payment received. On the other hand, if the threshold is not met, no payment at all.
While it is true that binary options may provide the potential for high profits, it could also expose you to unnecessary risk which could lead to a significant amount of loss.
Always be skeptical when unregulated platform providers advertise binary options as “trading with zero risk”, “trading amounts of as little as $1”, or “profit payout of 500% per trade”. These are indications that these platforms are using Binary Options. They also tend to be based outside Singapore and you will unlikely be able to recover any amount of money lost should anything happen to the platform.
#3 Singapore Uses Warrants Instead of Listed Options for Trading.
Do note that Singapore uses structured warrants as the market equivalent of options instead. Like options, warrants are contracts between the issuer and the investor that allows the investor the right but not the obligation to buy or sell the underlying stock at a fixed price during expiration.
They are securitized so that they can be traded like a stock in a derivatives exchange.
Warrants and Options also work the same way when it comes to call and put. However, they also differ in a lot of ways.
Here is a list of the main differences between structured warrants and standardised stock options, as listed by OptionTradingPedia.com :
Structured Warrants Standardised Stock Options Contract Terms Defined by issuer Standardised by exchange Trading Cannot be freely shorted Can be shorted Strike Prices Only those issued Usually a lot more strike prices and expiration Delivery Delivered by issuer Delivered by investors.
#4 There is Not Much Difference Between Options in Singapore and Options in US.
Options listed in Singapore are not much different from those listed in the US. At the onset, an option is simply a derivative based on an underlying instrument. There is no difference.
However, the only thing that contrasts the two is the size of their markets. The US market is wider and deeper. So there is a lot of liquidity.
There are also options listed available in US stocks. This provides a wider selection of trading choices for traders.
#5 Many Option Traders in Singapore trade exclusively in the US.
Since the rise of online platforms in trading, more online options trading brokers allow Singaporean investors to trade on their platforms. As a result, options trading in the US market has become more accessible to traders in Singapore.
Singaporeans can now directly conduct options trading in the US market which is more convenient to them in terms of having their money wired to and from their accounts.
The most important reason why Singaporeans do this is that the US market is the biggest and provides more liquid options in the world. Therefore, there are more trading opportunities and grants exposure to international blue chips.
Furthermore, the US Market’s standardised stock options come with a lot more strike prices across more expiration dates.
Conclusion.
We’ve covered the fundamentals of Options trading in this article. Undeniably it is a complicated instrument with many factors affecting its price.
It takes time to get the hang of, however, it would pay off in the long run if you decide to start using it to boost your investment returns safely.
If you’re ready to take action after reading this article, then jump onto our next article where we share 2 simple but actionable Options Strategies that beginners can use to pocket extra returns. They are the same strategies that’s also used by Warren Buffett!