Hedging
ASX CFDs provide you with access to a range of strategies to protect your existing portfolio without limiting your upside potential. ASX CFDs can be used with Exchange Traded Options (ETOs) to provide access to protective strategies that offer greater flexibility and may more cost effective than OTC CFD guaranteed stop loss orders.
ASX CFD/ETO Protection Strategy
The strategy you will adopt will vary depending upon whether you have bought or sold ASX CFDs.
ASX CFD Position | ETO Position |
Long – purchased ASX CFDs | Purchase a put option in the underlying share to protect your long position |
Short – sold ASX CFDs | Buy a call option in the underlying share to protect your "short" CFD position. |
Benefits of the ASX CFD/ ETO Protection Strategy
The combination of ASX CFDs and ETOs provides additional benefits to manage your risk when compared to traditional guaranteed stop loss.
ASX CFD/ETO protection strategies protect your position if the price of your ASX CFD moves beyond your down-side price limits. When employing this strategy the trade remains open this provides you with the time and flexibility to review your trading decision prior to acting while you are protected from any further downside risk.
- Cost effectiveness – Employing an ASX CFD/ETO protection strategy may provide you access to greater cost effective protection when compared to OTC guaranteed stop loss products.
The cost effectiveness of using this strategy will depend upon the characteristics of the option contracts used. Additionally if you do not need to exercise the ETO to protect your ASX CFD position, the options, unless expired, will retain some value that can be realised by selling the option back into the market.
When employing the ASX CFD/ ETO Protection Strategy the following should be considered:
- Choose an appropriate protection level
Ensure you select an option with the exercise price (strike price) at the level appropriate to the amount you want to risk on the trade.
Eg – If you hold a long ASX CFD position at $20 and want to protect the position from a price movement below $19, you would purchase a Put Option with a strike price of $19.
Alternatively, if you held a short ASX CFD position at $20 and want to protect the position from a price movement above $21, you would purchase a Call Option with a strike price of $21.
- Choose an appropriate term
Ensure you select an option with the expiry price appropriate to the how long you expect to hold the ASX CFD position.
- Choose an appropriate number of contracts
Ensure you choose option exposure appropriate to your ASX CFD position. An ASX option contract represents 1,000 shares of the underlying stock. If you hold a CFD Equity position of 10,000 long ASX CFDs to hedge this position you would be required to purchase 10 Put Options. Conversely if you held a 10,000 short ASX CFD position you would purchase 10 Call Options to protect the position.
As Option contracts sizes are in multiples of 1,000 you must choose to be over or under hedged if your position is not in multiples of 1,000.
Examples of a combined ASX CFD and ETO position
Protecting a long ASX CFD position in XYZ
Amy holds 1,000 ASX XYZ CFDs at a price of $20.00. A Put Option is purchased at $19.00 to protect the downside risk on the position. CFDs is limited should the price of ASX XYZ CFDs move below the put option strike price of $19.00. However, the potential profit / loss on the trade remains unlimited.
If Amy decides to close her long ASX XYZ CFD position, she has two options in relation to her ETO holdings:
If the Options contracts are “in the money”, (ie the shares are trading below the strike price) Amy could either sell the Option or exercise the ETOs ie sell the physical shares (if they she owns the physical shares) at the strike price.
In both instances, the profit will have provided her with the required protection.
If her ETOs are “out of the money”, (ie the shares are trading above the strike price) she can sell them on ASX with the proceeds reducing the cost of protection.
- Amy purchases 1,000 ASX XYZ CFDs at 2000 ($20.00).
Amy protects her “long” ASX CFD position from a price movement below $19.00 by buying put options.
She expects to hold the ASX XYZ CFD position for up to a month, so she selects a put option with a $19.00 strike that expires after this time.
Each option contract represents 1,000 shares and, therefore, she purchased 1 put option contracts to protect her 1,000 ASX XYZ CFD position.
Protecting a short ASX CFD position in ABC
Steve knows that once he has the call option in place the upside risk on his 5,000 ASX ABC is limited should the ASX ABC CFDs move above the call option strike price of $5.50. He has not limited the position’s potential profit from any downwards movement in the price.
If Steve decides to close his long ASX ABC position, he has two options in relation to his ETO holdings:
If his ETOs are “in the money”, (i.e., the physical shares are trading above the strike price) he can sell the ETO or exercise the ETO and buy the physical share at the strike price. In both instances, the profit will have provided the required protection.
If his ETOs are “out of the money” he can sell them on ASX with the proceeds reducing the cost of protection.
It should be noted that when employing an ASX CFD/ ETO protection strategy that your position will not be automatically closed out as is the case with an OTC guaranteed stop loss.
- Steve has sold 5,000 ASX ABC CFDs at 550 ($5.50).
Steve protects his “short” ASX ABC CFD position from a move above $6.00 by buying a call option.
Steve expects to hold the ASX ABC CFD position for up to two weeks and so he selects a call option with a $6.00 strike that expires after this time.
Each option contract represents 1,000 shares and, therefore, he buys 5 call option contracts to protect his 5,000 ASX ABC CFD position.