The Secret Broker: How to value options and what not to do in Amsterdam
After 35 years of stockbroking for some of the biggest houses and investors in both Australia and the UK, the Secret Broker is giving Stockhead the wisdom of all his experience and war stories from the trading floor to the dealer’s desk. This week he turns his attention to company issued options.
In 1985, as I was learning about the wonders of option trading, our Dutch Head Trader suggested that I should come over to Holland and meet some of the traders on the Dutch Futures Exchange. He was 32, had gone prematurely grey, drank like a fish and was making a fortune trading options.
Obviously, I’m in.
I soon discovered that the Dutch not only have a wicked sense of humour but they were also considered to be the pioneers of creating and trading options.
The Dutch invented options trading in the 1700s, when merchant ships would sail from Amsterdam and return full of goods from faraway places. As it was hit and miss that a ship would ever return, ship owners would hedge their bet by selling an “option” over their cargo.
For a fee, a speculative merchant could buy an option over the cargo and if the ship made it back, he could exercise the option at an agreed discount to the market value of said cargo. If the ship was shipwrecked, then he would lose whatever money he paid for that option.
But if word got back that the ship was safe and two months away from returning, he could sell his option on, for a profit to another merchant.
The nearer the ship got to port, the higher in value the option went up.
Upon arriving on the floor of the Dutch Futures Exchange, we were greeted by likewise young, grey-haired traders in brightly coloured jackets. They took us around to different trading pits and we talked about volatility, put options, call options and compared notes on warm beer vs Oranjeboom.
Halfway through the tour, they explained to me that it was traditional that I have a large pair of wooden clogs handmade for me to take home as a gift.
How lovely, I thought, taking off my smart shoes and trying on a pair for size.
At which point one of the traders promptly ran off with my shoes never to be seen again, leaving me dressed in an expensive pin striped suit and oversized wooden clogs.
In such fashion, I had to continue the tour of Amsterdam including all the night spots that young nouveau riche grey-haired option traders frequented.
Needless to say, the morning flight back with a sore head and still wearing my wooden clogs and suit was a memory that has stayed with me forever.
Oh yes, options. A Stockhead reader recently emailed to ask me to look at the options issued by New Century Resources (NCZ) and how they impact the company’s valuation.
Both unlisted and listed options have been around on equity markets for many years. In Australia, listed companies seem to have a bent on issuing them and NCZ is no exception.
NCZ re-listed in July 2017 after raising funds at 15 cents per share, to recommence the operations of the Century Zinc Mine in Queensland. Having successfully re-opened the mine in September 2018, it is currently trading at 88c.
Very good indeed. But with 115m unexercised options on issue how does one correctly value the company?
Numerous ways, actually. Especially when the company has so many different options and exercise prices on issue. Luckily, this one has made things a lot easier (a nice change) by summarising them on page 4 of their recent investor presentation, issued to the ASX on 11th of April 2019. Here’s your cut-out-n-keep version:
So, the overall effect of the valuation by taking into account all the unlisted options would be a discounted valuation of 9% to the current share price of 88c.
And do we have a black tulip bulb or a pair of wooden clogs in this one?
That would depend on the zinc price behaving itself and whether the company can repay debts without the need for any more funds outside of those options.
Here endeth the lesson. Now go find your shoes.
Do you want the secret broker to run the ruler over a particular stock? Email: [email protected]