Strategies for trading options on the Hong Kong stock exchange

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Hong Kong is an international financial hub that offers many types of trading opportunities for people interested in trading, whether they are experienced or new traders.

There are also multiple ways that traders can access these markets. Hong Kong stocks are available on major stock exchanges, including New York, Singapore, London, Canada, Tokyo, Shanghai and Sydney through ADR’s (American Depositary Receipts) and Global Depositary Receipts, traded in U.S Dollars or Euros.

With so many exchanges to choose from, traders who work with an online trading broker can select the markets they want to trade based on their investment strategies and interests.

Trading styles available

If you’re looking for effective ways to start trading options, then there are several different trading styles that you could try. The most common way that people trade options is through “buy-writes”.

The idea behind this strategy is simple – someone buys an underlying stock (or index) while simultaneously writing out-of-the-money call options against it. 

When combined, these two positions make up what’s known as a synthetic long stock position. The reason why it’s called a synthetic long stock position is because the strategy returns similar profit potential as owning shares of the underlying security but with significantly less risk exposure.

As we’ll see below, this combination also helps manage and lower your capital exposure, allowing you to earn more money on your trades potentially.

Case study:

The best way to understand how buy-writes can be used as an effective trading strategy is by understanding the all-important Greeks (the Delta, Gamma, Vega and Theta values).

To keep things simple, let’s assume you’ve bought one lot of BABA – the ticker symbol for Baidu Inc (ADR) with a current price of $155/share and sold ten out-of-the-money call contracts with a strike price of $160 that expire in 4 weeks.

You’ve just created a synthetic long stock position by selling the calls against your physical stock (BABA). Now, let’s assume that Baidu Inc announced its earnings three days later. The share price drops down to $150/share following the announcement, and at the end of trading, it’s time to take profits.

Unfortunately for you, though, you’re forced to sell your shares at market price because not only did the stock drop but now all those calls that you wrote no longer have any value. Naked or uncovered call options lose 100% of their value if the underlying security closes below the strike price at expiration.

For this reason, many traders will instead buy-to-close the call position to protect their downside on the stock. This is done by selling enough out of the money calls with a higher strike price that will offset your loss if the underlying security trades below your original short strikes.

Let’s assume we sell 15 contracts with a $165 strike and collect $660 in premium (the same outcome would occur if we sold 20 contracts):

We break-even at Baidu Inc. (BABA) at $158.35/share, which means we’ve minimized our losses and helped to control risk exposure (in this case, we were able to reduce our capital exposure from $6,300 [($155 X 100 X 10) – 660] down to only $3,200).

It works because the Gamma (Γ) value of our short calls ended up offsetting some of the losses that occurred on our stock position. This means that by selling more call contracts against your long stock, you can help to control and minimize your downside risk exposure, essentially giving yourself a limited loss if the underlying security clpagoses below the strike price.

In addition to being used as a speculative strategy at expiration, buy-writes can also be used conservatively throughout the life of an option contract. If you’re looking for ways to manage your capital while still setting up trades with favourable risk/reward potential, then consider writing out-of-the-money covered calls to earn extra income from premiums.

An excellent strategy for this is known as a “buy-write”, where you can buy an underlying stock (or index) at the same time you write out-of-the-money call options against it.

Using the previous example, let’s say instead of selling ten contracts with a $160 strike price, we instead sell 20 contracts with a $165 strike price.

We’ll still collect the same total amount in premium ($660) but end up paying less for our shares because we’re selling more options against them:

We make some money on both trades, but by selling twice as many calls, not only did our net cost to enter this position go down, but even if Baidu Inc. were to rally back to its original pre-earnings price, we’d still be able to sell our shares at a higher market price.

In effect, we’ll make more money on both trades. Still, by selling twice as many contracts, we not only increase the amount of premium collected but also reduce our capital outlay and downside risk exposure.

In conclusion

The best way to learn how all this works in actual practice is through paper trading. Make sure you use a demo account with an options broker such as Saxo that allows you to see your entire profit/loss history (not just end-of-day statements).

It will allow you to do research &backtest various options strategies while keeping your initial deposit safe from potential losses during demo trading.

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