JOHANNESBURG STOCK EXCHANGEEquity Derivatives

Part 1 – A brief introduction to Equity OptionsEquity Options

A brief introduction to Equity Options

Underlying Securities

Expiry date

Exercise/Strike price

Contract size

Implied Volatility

On SAFEX, options are traded on most of SouthAfrica’s largest and liquid companies, including AngloAmerican, Telkom Group, Sasol, Naspers, MTN and allSouth African banks. Options are also available onmost FTSE/JSE Indices. The FTSE/JSE Top 40 Indexis the most popular index for options.* JSE options canbe based on either physical or cash settled futures. Inthe case of physical settled futures, the buyer andseller would be required to exchange the physicalstock. For cash settled contracts, investors will onlyrealise the profits/losses in the derivative marketwithout ever exchanging the physical script.

This is the day in the future on which all unexercisedoptions for the specified contract date will expire. OnSAFEX, options generally expire on the thirdThursday of March, June, September andDecember. These dates correspond with SAFEX’sequity market close-outs when all the contracts forthat expiry are settled. Upon expiry the option willautomatically be exercised if it is in the money (e.g. ifthe expiry price is 1 cent or more above the strikeprice). It will convert into a Single Stock Futureexpiring on that day. That evening investors willrealise a futures profit/loss on SAFEX.

This is the agreed price at which you will buy or sellthe underlying securities if you exercise the option inthe future. In order to force liquidity, SAFEX sets theinterval of these prices. The strike interval for SingleStock Options is 50c, and 50 points for options onthe FTSE /JSE Top 40 Index.

One option contract covers 100 underlying shares(1 futures contract) In the case of index options; thecontract value is currently fixed at R10 per index point.

Volatility indicates the size of the underlying security’sprice movements as a percentage. Even thoughhistoric price movements are used as a base, marketconditions and sentiment will also reflect in the finalvalue. There is a direct correlation between volatilityand the premium paid; the higher the volatility, themore expensive the option. SAFEX calculates andpublishes an accurate volatility daily. The transparencyof volatility on SAFEX is one of the key differencesbetween the Equity Options and Warrants market.

Part one of a series of Options brochuresbrought to you by the JSE

Introduction

Price of an Option

Ever needed more time to decide if you want to buy orsell a share?

Ever owned shares and wanted to protect them againstfalling markets?

Ever thought it's a good time to buy shares but you don'thave the money immediately?

Ever wanted to earn extra returns on your existingportfolio?

Options are not new financial instruments; they’ve beenaround since the 1600s when the Dutch tulip farmers usedthem to protect/insure their harvests. There are two types ofoptions traded on the JSE’s Equity Derivative market(SAFEX), and

give the buyer the right, but not theobligation, to buy the underlying shares at apredetermined price in the future, while

give the buyer the right, but not theobligation, to sell the underlying shares at apredetermined price in the future.

In order to obtain the right but not the obligation to buy theMTN share at R150, the option buyer pays the option sellera “premium”. The premium is therefore the price at whichthe option writer agrees to sell the option to the investor.Note that the premium excludes transaction and brokeragecosts. This premium is paid over the life of the contract asoptions listed on the JSE are futures style options. Thefollowing are critical

of an option: Underlying Securities, Expiry date,Exercise price, Contract size and Volatility.

Ask your broker how JSE Equity Options can give you

the right (not the obligation) to buy or sell shares at

predetermined prices in the future…

call options put options.

Call options

Put options

components in calculating thepremium

For example, a SEP MTNQ 150 Call option gives the

purchaser the right to buy 1 single stock futures (SSF)

contract, (which equates to 100 underlying shares) in MTN

for R150.00 per share, on or before the expiry date of the

option in September. If the holder (buyer) decides to

exercise the option, the writer (seller) of the option must sell

1 MTN futures contract at R150 per share, regardless of

what the MTN share price is on the day. Note that the holder

of the option is not obligated to exercise the option. The

buyer may sell the option before expiry, or could let the

contract lapse at expiry, in which case the option holder will

only lose what was paid for the option.

*The JSE does not list futures andoptions on illiquid instruments.

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www.jse.co.za

Benefits of Options

There are several sound strategic reasons for investors touse options. Some of these reasons are listed below.

allow investors to protect the value of theirshares against a declining underlying security price.Buying a put option locks in the sale price of the investor'sshares for the duration of the option contract, no matterhow low the share price may go.

Without using put options, in a market downturn you haveno protection against prices declining except to hang onand wait for better times or to sell your equities forwhatever you can obtain in the market.

Options are often described as the only guaranteed stoploss, as falling markets cannot gap through the agreedstrike price.

Put options

For example, if in early February you believe the SSF price

of Old Mutual Group (OMLQ) is going to fall from current

levels of R20 to around R15, you could buy a MAR OMLQ

20 Put option, for R116 per contract. (R1.16 per share)

This option gives you the right to sell your OMLQ futures at

the exercise price of R20 at any time up until the option's

expiry. A major benefit of this strategy is that if the share

price rises, you are not obligated to sell your shares. Your

shares will benefit from any price rise, and all you have lost

is the put option premium of R1.16 per share.

Investors can earn extra income on their equity andfutures holdings by writing (selling) call options onshares or SSFs that they own. This is an attractivestrategy for investors who expect the price of theirshares to remain constant or fall slightly. Writing calloptions can be a good way to generate extra incomewhen the market is flat or slightly negative. Writingoptions is not for the novice investor and needs to beunderstood.

For example, assume you own 100 shares in Standard

Bank (SBKQ), which in early July are trading at a SSF

of R74. You believe that over the next

couple of months, the share price is likely to maintain

its current levels. You write a SEP SBKQ 80 Call option

for a premium of R240. Writing/selling the SEP 80 Call

means that you accept the obligation to sell your

Standard Bank shares for R80, if the option is

exercised. For this you receive the premium of R2.40

per share (R240 for the contract).

Fair Value

Protect the value of your shares

Extra Returns through Covered Calls

If at expiry (September), the share price is below R80,

the option should expire worthless. Your SBKQ shares

may have decreased in value, but you have earned

R240 in extra income for selling the call. Because of the

extra income, in this example the single stock futures

price must decline below R71.60, for you to make a

loss on the strategy as a whole. If, however, the share

price rises above R80 at or before the contract's expiry,

the option will be exercised and you will have to sell

your shares. Effectively you have sold your shares for

R82.40, R80 for the shares and the R2.40 per share

option premium.

Option trading strategies are explained in Part 3 of theOptions brochures series.

Investors and traders can use options to profit from amovement in the underlying SSFs and shares without thecosts of trading the shares themselves. Options give youexposure to movements in the share price for a fraction ofthe cost of purchasing the shares themselves. Because ofthe small initial outlay on margin, you can obtain gearedexposure to share price movements.

With an increase in the price of the underlying shares, thetotal percentage return on the purchase of a call option willbe greater than on the purchase of the underlying stock.

Similarly, if the price of the underlying shares fall, thepercentage return on the purchase of a put option will begreater than the percentage change in value of the shares.

Buy NTC share in May: R7.90*100 R790.00

Sell NTC share in September: R9*100 R900.00

Profit (R900 – R790) R110.00

% Profit (R110/R790) 14%

Buy SEP NTCQ R7.90 R50.00Call for a premium of R50

Profit (R900 sale price – R790 R60.00strike price – R50 premium)

% Profit (R60/R50) 120%

For example, assume it is the middle of May and you

believe the price of Netcare (NTC) will increase

substantially by September In the below table we contrast

buying the equity at R7.90 with buying an R7.90 strike

price call option with buying the underlying shares.

Speculate

Share Profit

Options profit

Electronic versions of the brochures are available at the following URLs:• Part 1: http://www.safex.co.za/ed/docs/options/A_Brief_Intro_To_Options.pdf• Part 2: http://www.safex.co.za/ed/docs/options/JSE_Equity_Options_Explained.pdf• Part 3: http://www.safex.co.za/ed/docs/options/Option_Trading_Strategies.pdf

Disclaimer: This document is intended to provide general information regarding the JSE Limited (“JSE”) and its products and services, and is not intended to, nor does it, constitute investment or other professionaladvice. It is prudent to consult professional advisers before making any investment decision or taking any action which might affect your personal finances or business. All information as set out in this document isprovided for information purposes only and no responsibility or liability (including in negligence) will be accepted by the JSE for any errors contained in, or for any loss arising from use of, or reliance on this document.All rights, including copyright, in this document shall vest in the JSE. “JSE” is a trade mark of the JSE. No part of this document may be reproduced or amended without the prior written consent of the JSE.

Compiled: July 2009.

www.jse.co.za

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Futures account or open a SAFEX account with a broker.A client agreement form and risk disclosure statement willhave to be signed. A broker will provide you with thenecessary documents.

There are 2 types of margins: initial margin and variationmargin. is a relatively small deposit – incomparison to the nominal value of the contract – whichboth the buyer and seller must lodge with the clearinghouse as security. This initial margin is a good faithdeposit that is returned to you with interest when you exityour position. With , your daily profit orloss is calculated. A loss requires payment to the SouthAfrican clearing house via your broker. Each day theposition is open, the initial margin and the variation marginare calculated. Your initial margin fluctuates as the valueof the option and the risk associated with the optionfluctuates. Each night, the exchange recalculates thecurrent price of your option as if you were to purchase ittoday. The option holder will receive cash if the option hasincreased in value, and pay in cash if the option hasdecreased in value. This process is similar to that for afutures contract, with the addition that changes in theimplied volatility of your option are also taken into accountin our calculations. Once again, the maximum lossincurred is limited to the premium paid.

Margining is explained in detail in Part 2 of the Optionsbrochures series.

For additional information contact:

Tel: +2711 520 7000

Email: options@jse.co.za

www.safex.co.za/ed/products_equity_options.asp

An initial margin

a variation margin

The JSE’s options on equities and equity indices are. This means that they are

and the premium ispaid over the life of the contract, only settling atexpiry. They are also margined over the life of theoption. This margining helps to ensure that marketparticipants are protected from defaultingcounterparties. Like any investment, options haverisks that you need to understand before investing.Please consult your broker before investing.

JSE Limited – Derivatives Trading Division

options on futures

exercisable into futures contracts

Margining

Contact information

In the above example the percentage return from buyingthe call options is significantly greater than the return frombuying the shares. That is because in both scenarios youmade about R100, but for the option position it only cost youR50 to gain that exposure whereas in the underlying sharemarket it would have cost you R790 for the same return inRand. However, just as leverage provides the potential toearn higher percentage returns, it also involves the risk ofsustaining larger percentage losses.

There may be times when you aren't certain if you should goahead with the purchase or sale of shares. Buying an optionenables you to defer your decision until the option's date ofexpiry.

By buying a call option you lock in the purchase price of theshares. You then have until the expiry date to decidewhether or not to exercise the option and buy the shares.Similarly, by purchasing a put option you ensure a fixedselling price, and give yourself time to decide whether or notto proceed with the sale of the shares.

In both cases, the most you can lose is the premium youhave paid for the option.

Index options are similar to share options with the exceptionthat they are exclusively cash settled. Upon expiry theinvestor will therefore receive or pay the difference betweenthe final closing price and the strike price. Index options arebased on a basket of stocks as opposed to a single stock.

By using index options, investors can therefore effectivelytrade a selection of stocks in one transaction. If you hold aview on how the equity market as a whole will perform,buying or selling index options is an easy and cost-effectiveway to trade your view. Index options provide diversifiedexposure, without having to invest directly in the manystocks that make up the index.

You place an order through your broker, just as you wouldwith shares or futures. Your broker will attempt to find acounterparty prepared to sell you the desired option.Options are traded on Nutron, an automated trading systemlinking derivatives brokers from all over South Africa. Inorder to trade options, clients will have to use their existing

Transaction costs and brokerage fees were excludedin all examples for simplicity.

Time to decide

Index Options

How Options are traded