NZX relaunches arcane system of share options

Jelly rolls, straddles and strangles are some of the strategies used in a complex form of share trading - options - relaunched by New Zealand Exchange (NZX) today.

However, even NZX concedes this third endeavour is less than optimal.

The disadvantage of using the SFE's platform is that only accredited SFE members - of whom there are only four in New Zealand - will be able to directly trade the options.

As well, the SFE system requires traders to put up cash equivalent to the underlying shares as collateral rather than simply deposit the underlying shares as the Australia Stock Exchange (ASX) scheme does.

The options will be traded through the Sydney Futures Exchange (SFE), rather than NZX's own exchange which was the preferred option so to speak, but would have cost millions to establish.

The complexity of options and its impenetrable jargon may be one reason why share options trading failed in its first two attempts. Experts warn options can enhance earnings but are not for the uninitiated.

Five share options based on the biggest and most heavily traded stocks -- Carter Holt Harvey, Contact Energy, Fletcher Building, Telecom and The Warehouse --- will debut on the SFE tomorrow.

Options are contracts to buy (call) or sell (put) an equity at a fixed price on, or by, an agreed date. They can limit losses or allow traders to make a premium.

Derivatives trading has been given a bad rap by the likes of Nick Leeson, who infamously broke Barings Bank, but options trading has taken off in a big way in the US and Australia.

US options expert Bud Haslett of Write Capital Management who has been bought to New Zealand to promote the concept, said options-related trading accounted for nearly half the trading in the US equities market.

Options increase returns, lowered risk and could be used like insurance.

"Everyone thinks that options are risky, but you can lower risk and volatility," Mr Haslett said.

However, he said an option was like a scapel -- put it hands of a skilled surgeon and it could do a lot of good, but put it in the hands of a criminal "and it can cause a lot of havoc".

There could be "headaches and unintended consequences."

Mr Haslett said the volumes of options traded was exploding worldwide with compound growth in the US of 20 per cent per year for the last seven years. In Australia, the market had been growing at 12.5 per cent a year.

NZX head of markets Geoff Brown said it had taken 18 months and thousands of hours to set up the scheme.

NZX was making a low key launch and Mr Brown admitted "we're not are not getting rushed off our feet" by players wanting accreditation.

Roger Barley of SFE accredited Sydney brokerage Tricom said there would be problems with NZX not having its own exchange. He said non-accredited brokers would be reluctant to use accredited brokers for fear of losing clients.

NZX is hoping Goldman Sachs JB Were will become actively involved in as a market maker -- a broker that will make two-way prices. That could give the market critical mass to take off.

NZX is promoting options trading because it expects it to boost the underlying market. Every options trade requires an equivalent trade in the physical market.

Mr Brown said the earlier attempt to establish an options market fell down as there was only a call market and no put market because of legal limits on short selling of shares (agreeing to sell shares you don't own). There was also no facility to margin trade -- sell an option half way through its life.

There was only one market marker at the time -- SBC Warburg -- and often pricing was in the market-maker's favour.

"We have a slightly broader base this time and the challenge will be for us to make sure those organisation are going to be there and that they create competitive prices," Mr Brown said.

The New Zealand Futures and Options Exchange (NZFOE), which was later sold to the SFE tried to establish an options market in 1989. However, it was pre-empted by the stock exchange's short lived effort.

Lincoln Gould, formerly of the NZFOE, said NZFOE had tried to get small investors interested but they were still suffering from burnt fingers from the 1987 share crash.

"At enormous effort went into educating the public, but it failed to get critical mass."

The stock exchange scheme quickly folded and the NZFOE scheme died a few years later when NZFOE was distracted by its sale to the SFE.

Mr Brown said "the view from afar was that the marketplace just wasn't ready for options and I'm extremely confident that it is ready now".

Mr Haslett believes there was a good chance the New Zealand market would fly within a year "and I'm certainly confident it will work within two years".

- NZPA