An option is a privilege which provides the buyer of option a right, but not an obligation, to buy or sell a share at a specified price on or before a specific date.
There are 2 types of options:
Investing in options by SMSF
In a superannuation environment, SMSF’s trustees are allowed to invest in options as a way to boost their investment savings, subject to certain conditions:
- The fund’s investment strategy and the trust deed permits investment in options,
- Regulation 13.15A of SIS Legislation allows a trustee to give a charge over an asset of the fund in order to comply with the rules of an approved body. In that instance, the fund must have a derivative risk statement.
- The derivative risk statement details the fund’s policies for derivatives, the risk associated with them and the controls in place for the management of derivatives trading.
However, an SMSF cannot invest in all types of options, particularly naked options. Naked options, also sometimes know as naked positions where the writer of the option does not hold the underlying stock.
When the SMSF as a writer, intends to trade a naked Call option, the fund is more likely to be exposed to a high risk of buying the underlying stock at a much higher price on the market in order to make delivery at the lower price to the buyer. Therefore, the risk of loss is unlimited depending on how high the share price may get, and as such how much the fund will need to settle its obligation as per the contract.
On the other hand, when the SMSF as a writer, trades naked Put option, and the market value of the stock falls below the strike price, the fund may have to buy the stock which may be less than strike price.
Income tax consideration
The income tax consequences of trading options depend on the purpose of trading, such as whether it is only speculation or hedging against a particular exposure.
However, when the taxpayer is a complying superannuation fund, the trading purpose is irrelevant. It is because section 295-85 of the ITAA 1997 Act generally treats the transactions on a capital account.