First of all, I am not one of the “market participant” and not related to any of them, but for me, it is very obvious that that Australian Clearing House does not know what they are doing in relation to collateral of call option from a security that is on suspension.
Monday, 8 Dec, I got the weirdest margin call I’ve ever know: my broker call ans ask me to deposit some money to cover the margin for my option position. Well, fair enough… but which one? The one needed margin cover is the Covered Call[1. should you want to know what covered call or buy write or “share renting” is, please read this introduction] Option position. The problem is that I have covered that position with the stock that being optioned itself.
I have covered call position on OZL (OZ Mineral Ltd) for December 2008 expiry date. As we know, on 1 Dec 2008, OZL have requested to suspend the trade of their security pending some refinancing issue. The suspension is expected to last up to end of December.
Then because of the suspension, both stock and option trading stop and basically all OZL security activity is being frozen on the market. And ACH then decide to declare the OZL security is illegible as collateral/margin. Have a look at the excerpt of ACH and ASX Market Notice #22308 below [2. the copy of the original documentation is on pdf format here]:
…ACH may from time to time require the removal of collateral securities lodged with ACH where these securities are subject to a corporate action or event. This is done in accordance with standard procedures which apply when any corporate action or event has collateral implications for ACH.
On 1 December 2008, OZ Minerals Limited (OZL) announced that the Company will be
suspended from quotation prior to the commencement of trading on Tuesday, 2 December
ACH and ASX Participants are advised that all OZL shares lodged as collateral with ACH
must be removed before or by the close of business, Wednesday, 3 December 2008. Any
collateral held after that date will be removed by ACH.
The Real Problem
The removal of collateral securities lodged with ACH is routine item and is needed to ensure the margining system is working smoothly. For example, people doing “Naked Put” for BHP securities can lodge OZL securities as the collateral instead of cash. Since OZL securities is non-liquid, it’s a reasonable and required decision to remove OZL securities as collateral and demand other collateral such cash or other security. I understand this fully and support it. BUT NOT FOR COVERED CALL !
People who buy the call option have the right to buy the security at strike price. So the collateral on covered call is just to make sure that the writer of the option have enough money to buy the securities from the market and sell it cheaper (hence making a loss) to the option holder that will exercise the option.
Now, having already the stock itself for collateral (Providing OZL securities for OZL call option collateral) is actually the most secure and reliable way to ensure smooth transfer in case of exercise. Once the option exercised, the ACH just need to transfer the security to the new owner. Nothing else to be done.
Asking cash collateral for call option is actually more risky. Imagine if the stock price shoot up 100%, then ACH will need to demand 100% of the amount. Then, what is the real reason to reject OZL securities as collateral of OZL call option ? Let see what is the possibility:
- If the OZL securities shoot up above the strike price of the option, ACH just need to hand out the stock to the option holder who exercise the option. That’s it.
- If the OZL securities goes down below the strike price of the option, no one will exercise the option anyway, so nothing to be done.
So, the real problem is ACH reject the securities that being optioned as collateral and asking cash margin which is more risky and totally unnecessary if you have the stock itself as the collateral.
Does Mr Eddie Farah who authorized the removal of all OZL securities, know about this basic fundamental of how option works? If he knows, why he still remove the collateral for the covered call? Does ACH know what they are really doing ? Anybody could lighten me up, please ?
The obvious effect for option writer is of course unnecessary margin call. People who hold about $50,000 worth of OZL securities have to lodge more than $15,000 cash collateral.
But the real damage for wider audience is losing confidence. Does ACH knows what they are doing? If the official clearing house of ASX does not know the real effect of their action, who does ? Or is this careless decision is just because of negligence of certain person only ?
What should happen?
The solution of this problem is just simple additional 1 line of English sentence of the notification. The market notification/decision should read:
ACH and ASX Participants are advised that all OZL shares lodged as collateral with ACH, except those lodged as collateral for OZL call option, must be removed before or by the close of business, Wednesday, 3 December 2008. Any collateral held after that date will be removed by ACH.
See… easy and everybody is happy ! Nobody can complain or whinge about this matter anymore, even me.
Is that easy enough or I am asking too much ?
If you are one of those affected, or market participant that tired being played by ACH or anybody else that care about the credibility and the correctness of stock market, please kindly have your thought heard via the comment box below. Thank you.
p.s: I have tried call the ACH and email them, but as expected, no one wants to talk to small retail investor like me. It seems the broker also does not seems interested to stand up for their customer. Hence this post!