Question of the Week

Questions of the Week

Co-founder of the Switzer Report
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Question 1: Apparently, the Federal Court has cleared the way for a merger between TPG and Vodafone Hutchinson. Will this be good for Telstra?

Answer: The merger won’t have any immediate impact on Telstra’s earnings, but in the medium term, should be a positive because it will have one fewer competitor. Effectively, an oligopoly of three  – Telstra, Optus and Vodafone/TPG. This is why the ACCC opposed the merger. There is a counter-argument that the merger might hasten the rollout of 5G technology by Vodafone/TPG, weakening Telstra’s leadership position. On balance, however, I think it has to be good for Telstra.

Question 2: In this week’s ‘Hot Stocks’, Michael McCarthy talked about put options against the ASX200. Are you able to explain this a bit further, what the benefits of this type of strategy are and how would one go about purchasing one of these?

Answer: Index put options give you the right, but not the obligation, to effectively “sell” the market at the designated strike price. Buying a put option is essentially a defensive or bearish strategy – if the market falls below the strike price, you win. If it doesn’t, you will lose the premium you invest.

Michael talked about buying 6650 June put options for a price of 115 points. Effectively, you can insure against any fall in the market below 6650 (the level of the S&P ASX 200) for 115 points (the premium).

So, if you buy the option and the market falls to 6000, you will make 650 points, less the premium of 115 points. If the market stays above 6650 and you never exercise the option, you lose your premium of 115 points.

Each option has a multiplier of $10 – so 1 index point is worth $10, 115 index points (in this case the premium) is worth $1,150. If the market falls to 6000, your option would be worth (on exercise) $6,650. To insure a portfolio of $1,000,000 value, you would need to buy $1,000,000/6650/10 – approx. 15 option contracts.

Important things to remember about index options are:

  1. The protection is time limited. The option has an expiry date (in this case, the 3rd Thursday in June), and if never exercised, it will expire worthless;
  2. These options are cash settled. They are not over the stocks that make up your portfolio – rather, the market index;
  3. They are European – which means that they can only be exercised on the expiry date;
  4. The price (premium) will change as the market moves, as the option gets closer to expiry (less time value), and according to volatility swings in the market.

You can invest in index options with most of the major brokers, and some online brokers such as CommSec. You will need to open a separate options trading account.

Question 3: CommBank (CBA) rose strongly on the day it released its profit report. It is back in the high eighties. Is CBA a sell now?

Answer: I wrote about CBA in Monday’s Switzer Report and today’s Switzer Daily. Here is my conclusion:

“I am not down on CommBank – it is head and shoulder above its major banks competitors in terms of core franchise strength, technology and leadership – but the premium difference is material and in an industry that is dominated by four major players essentially employing the same strategies, mean reversion shouldn’t be discounted. CommBank is not a sell per se, but I do think that for the medium term, CommBank is a sell to buy Westpac or one of the other majors.”

You can see the full article here.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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