Along with buying and selling stocks, there are a number of other way for investors to gain exposure to equity markets.

One of those ways is via options, and this week Stockhead got the rundown from domestic options trading firm Reach Markets to learn more about how it works.

As their name suggests, options give investors more flexibility on the construction of their portfolio.

In practical terms, options give investors the right to buy or sell an asset at a given price within a specified time frame.

Breaking it down further, let’s say an ASX stock investor buys 50 shares in Afterpay (ASX:APT) for $101.

They bought APT to get exposure to the BNPL boom, but they’re also worried the sector is running a little too hot.

So for the price of an option fee, they also buy the right to sell 25 APT shares at $100 at a given point in the future.

Now, let’s say the BNPL market tanks and APT shares fall to $75 before those options expire.

The investor will be down $25 per share on their underlying investment, but their options will be in the money. They now have the right to sell 25 APT shares for a profit of $25 each.

And if APT roars ahead to $125, they’ll only be down the cost of their option fee — a small price to pay for more BNPL riches.

The expert rationale

To learn some more about the market, Stockhead caught up this week with Pat Nelson, managing director at investment and options trading firm Reach Markets.

As we’ve alluded to, the broader options market is a complex space.

So it’s perhaps not surprising that Reach works predominantly with sophisticated investors (as defined under s708 of the Corporations Act).

“At Reach we’ve got around 5,000 ‘708s’ in our network and they love options. In many ways they prefer them,” Nelson says.

A lot of Reach clients use options “in concert with their equities portfolio”, Nelson said.

“They can use options to insure (hedge) their portfolio, generate additional income or get an exit point from something they own.”

“So you can approach it as a trader, but options are more so used on the basis of portfolios being managed.”

“Fund mangers and more experience investors will use them at different points in the market when they want to have insurance or reduce volatility.”

Another factor that appeals to sophisticated investors is that the options market is highly liquid and well regulated.

A feature of Australia’s options market is that it only covers 74 ASX stocks.

So “it’s not covering smaller caps”, Nelson said. “It’s very much a trading instrument for the bigger more liquid stocks.”

Punters need not apply

As one of the larger options trading platforms in the Australian market, Nelson said Reach is actively engaged with the broader trading community.

Those measures include the firm’s Trading 360 Summit, a five-week series of webinars taking place at the moment in conjunction with the ASX.

The most recent Summit session introduced an options trading game, where participants can learn the ropes with practical examples of actual options trades.

“Initiatives like the trading game are about building awareness in the market among investors,” Nelson said.

“We do lots of work on education side to teach people about the options market.”

That being said, “predominantly our focus is working with people who are serious about trading”.

“So for investors who are serious and willing to do work to be successful, we’d recommend looking at trading with us.

“But if they just want to have a punt on the options market, their chances of being successful are very slim.”