How does Options Trading work in an SMSF?

Options trading in a self-managed superannuation fund (SMSF) usually involves exchange-traded options (ETOs) or exchange-traded funds (ETFs). Over-the-counter derivatives are less common due to their volatility and customised nature. The Australian Taxation Office (ATO) monitors SMSFs for speculative use of derivatives, particularly when they raise exposure beyond the fund’s investment strategy limits. So, although it is legal to trade options in an SMSF there are a lot of rules that trustees need to understand and ensure they follow.

The SMSF landscape is experiencing a shift as younger, financially literate, and technologically adept investors enter the market. These new entrants are leveraging online trading platforms and research tools to diversify their investments into derivatives, including options trading, thereby influencing traditional, conservative investment approaches.

What is an option?

According to the ASX document “Understanding Options Trading,” an option is:

“A contract between two parties that gives the taker (buyer) the right (without obligation) to buy or sell a security at a set price on or before a specified date. To gain this right, the taker pays a premium to the writer (seller) of the contract.”

There are two main types of options: call and put options. A call option gives the buyer the right (but not the obligation) to purchase the underlying equity at an agreed-upon price before a certain expiration date. A put option allows the buyer the right (again, not the obligation) to sell the underlying equity before the expiration date.

The strike price is the set price at which an SMSF can buy shares when exercising a call option, or sell shares if holding a put option, on or before the expiration date. To acquire either type of option, the fund pays a premium, which reflects the intrinsic value (usually the current share price minus the strike price) as well as extrinsic factors such as remaining time until expiry and market volatility.

What is options trading?

This article covers exchange traded options, not over-the-counter options. Exchange traded options are bought and sold on public exchanges like the ASX. An SMSF must ensure options trading fits its investment strategy, is included in the trust deed, and is intended solely to provide retirement benefits for members.

SMSFs Trading in Options

SMSFs are permitted to trade options. Regulation 13.14 of the SIS Regulations prohibits SMSF trustees from placing a charge over, or related to, any asset of the fund. However, Regulation 13.15A allows trustees to place a charge over fund assets concerning derivatives, including options and futures contracts, if specific conditions are met:

• A charge cannot be placed over other assets of the fund
• The charge relating to the derivative contract must comply with the rules of an approved body, such as the ASX, Nasdaq, NYSE, or others listed under Schedule 4 of the SIS Regulations
• The SMSF must have prepared a derivatives risk statement
• The investment must align with the derivatives risk statement

Note: Cryptocurrency options are not permitted, as cryptocurrency exchanges are not included in Schedule 4 of the SIS Regulations and therefore do not satisfy the criteria for allowing a charge. Nonetheless, direct SMSF investments in cryptocurrency is still permissible and a relatively common investment choice.

Does the ASX require a charge for exchange traded options?

A charge may be imposed according to ASX rules or through your broker. If there is a margin call, an SMSF can pay it as long as no other fund assets are used as security. A charge can be placed over the options themselves if the above conditions are satisfied.

What is the difference between exchange-traded options (ETOs) and exchange-traded funds (ETFs)?

An ETO represents a contract granting the right, but not the obligation, to buy or sell a listed equity at a specified price within a defined timeframe. An ETO is considered to be a derivative and is required to have a derivative risk statement.

Not all ETFs are derivatives. ETFs investing into derivatives may be considered a derivate and a derivative risk statement may be required. An ETF is a managed investment vehicle, such as a unit trust, composed of a portfolio of assets including bonds, cryptocurrencies, Australian and international equities, property, precious metals, and foreign currency. ETFs typically aim to replicate the performance of specific indices or market sectors. For instance, the SPDR S&P 500 ETF tracks 500 major US companies, while real estate investment trusts (REITs) provide access to diversified commercial properties, including shopping malls, industrial facilities, hotels, and cinemas, for income or capital growth.

Both ETOs and ETFs are traded on the Australian Securities Exchange (ASX).