Covered Calls – What If I Don’t Own Shares? By Daniel Kertcher At Isnare.com Ezine Articles

Over the past few weeks, we’ve discussed Covered Calls, which are regarded by many professional investors as one of the most powerful investment strategies available. But what if you don‘t want to or can’t write calls against the shares you own, or don’t own shares, but have other investments? What are your options?

Margin requirements for writing Covered Calls

When you write a Covered Call, you must lodge your shares with the Option Clearing House (OCH) as margin. This step is required to ensure that if you are exercised your shares are immediately available to be sold.

As you are offering the shares as security, no further margin is required.

There is a second method whereby someone who owns shares may use those shares as collateral for the purpose of writing options. The OCH will assign collateral value to shares that have been lodged as security, this system works in the following manner:

The OCH has established three tiers of shares acceptable to be lodged as security:

Tier One Any share that has exchange traded options may be lodged as collateral. For example, you could lodge NCP shares for the purpose of writing BHP options.

Tier Two Is any share or units in entities within the ASX Fifty Leaders which do not fall within the shares listed in Tier One.

Tier Three Is any exchange traded security of Tier One shares, other than fully paid ordinary shares that meet the following criteria: Issued capital represented by the securities must be a minimum of $100 million, the minimum monthly volume must be in excess of 100,000 units and the minimum closing price must be at least $0.50.

In defining how much the collateral you have lodged is worth, the OCH applies a 30% discount to the market value of your shares.

The purpose of applying a discount is to guard against a sudden change in the market value of your shares. Such a treatment provides both you and the OCH with a buffer against unexpected market volatility.

Collateral must be lodged with the OCH by 4 pm of the day in which the trade is initiated. So if you put a trade into the market in the morning you must lodge your collateral by 4 pm on the same day. If you do not, the OCH will treat it as an uncovered position and full margins are payable in cash by 11 am on the following morning.

As well as taking shares as security, the OCH will accept a range of other financial instrument such as bank guarantees, certificates of deposit and non bank bills of exchange.

Let’s start trading!

Before dealing in the options market, you must complete and lodge the OCH Client Agreement Form.

This document outlines that you are aware of the mechanics of the options market, understand its risks and accept to be bound by its requirements. OCH forms are available from your broker and are usually included in the account opening packs which they will provide.

The options market also has slightly different settlement requirements to those associated with dealing in equities (shares). Settlement on options is required within 24 hours, or T+1. (Equity settlements are required within 3 business days, T+3).

Therefore, when you write covered calls, your account will be credited with the premium payment the next business day.

If you ever choose to take (buy) a Call or Put option contract(s), then most brokers will insist on a cash balance being established in your account before agreeing to enter the market on your behalf.

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