Protecting your share portfolio within your SMSF
A Put option gives shareholders the right – without the obligation – to sell a specific number of shares, at a specific price, within a specific timeframe.
This strategy works by enabling the investor to purchase shares at a ‘locked-in’ price, or premium. The shares could be sold later at the locked-in price if the market value of the shares were to fall. Alternatively, the shares could be kept and the ‘Put option’ sold.
When you buy Puts, you will profit when a stock decreases in value. For example, before the 2008 crash, your Puts would have increased in value as your stocks declined. Although Puts don't necessarily provide 100 per cent protection, they can reduce loss – it's similar to buying an insurance policy. The most you will have at risk is the amount you paid for the Puts.
Just as you’d expect insurance on more expensive items to cost more, Put options over higher-priced shares come at a higher premium.
Maryanne’s story
Maryanne is the trustee of a self-managed super fund (SMSF). She decided to purchase 1,000 shares in OzCo Ltd because she believed the assets were suitable. However, she wanted to limit the potential loss on the shares if the market price fell.
To protect the SMSF, she decided to purchase Put options.
Maryanne made the following investment:
|
OzCo Ltd without Put option |
OzCo Ltd with Put option |
Cost of OzCo shares |
$55 |
$55 |
Cost of Put option |
N/A |
$2 |
Total share cost |
$55 |
$57 |
Value at risk |
$55 |
$2 |
Maryanne purchased the options with an expiry date falling at the end of the financial year. This meant that at any time, up to the expiry date, Maryanne had the right to sell the OzCo shares for $55.
Purchasing the Put option did not restrict the earning potential of the shares, but allowed Maryanne time to consider her course of action if the market began to decline.
A month before the expiry date, OzCo Ltd shares experienced a downturn and their price reduced to $48. Ordinarily this would result in a loss of $7 per share, but Maryanne decided to use her options. She sold the shares at $55, which meant the real loss was only $2.
In this scenario, Maryanne’s use of Put options helped to protect both the SMSF’s value and the interests of the SMSF’s members. But what would have happened if the share price had increased? Even though the original purchase price was $55, the fund would not have begun to show a profit until the price rose over $57 – the price of the share plus the Put option.
Although Maryanne’s strategy worked in her case, it may not suit everyone. Please contact us on 02 9318 6400 or fred.tortora@surrypartners.com.au to find out if Put options can help to protect your SMSF.
Source:
www.asx.com.au