Future options

That don't break the bank. David Porter advises

T he turmoil in global stock markets over the past two weeks understandably makes investors think about how to lock in gains without necessarily dumping shares or triggering a liability to capital gains tax.

Until then the London stock market had been within spitting distance of its all-time high. The last interest rate cut should have stabilised London shares for a bit longer. But that was completely overshadowed by plunging markets on Wall Street. London markets followed the US stock market fall causing investors to revise views on where they think shares will head now. A general election is looming - another dampening factor.

Some may conclude that the negatives outweigh the positives - that shares are due for another dive. The bulls have had a good run. Over the past 12 months investors have seen the values of share portfolios soar. Over that time the FT-SE 100 index, comprising shares in Britain's largest companies, has risen almost 20 per cent.

Can investors lock in some profit so that if the bears gain the upper hand they do not lose all of their hard-earned gains? They could sell some shares. That takes nerve as they will lose out if the bullish noises from some quarters turn out to be right. As well as ruling out any further capital gain they would also lose dividend income generated from the shares. Selling shares could also increase an investor's tax burden. Gains up to pounds 6,000 in this tax year are exempt from capital gains tax. But if an investor is already close to breaching that limit before the end of the tax year on 5 April then any sales will probably incur extra tax.

Traded options offer one possible answer to investors' prayers. Tony Hawes, manager of equity products at the London International Financial Futures and Options Exchange (Liffe) thinks they should feature in most investors' financial planning toolkits. "Buying a `put' option guarantees a minimum sale price on 68 of the most actively traded shares," he says.

First investors should look to see whether any of their shares feature in the 68 on which options can be bought and sold. To do this they can either ring their stockbroker or examine the statistics pages of the Financial Times at the local library.

Principally, the 68 are the UK's largest quoted companies and range from supermarket group Asda to pharmaceuticals giant Zeneca.

Traded options are a bit complicated at first glance. That is why Liffe runs training courses up and down the country for investors. But for each of the 68 most traded shares there are two types of contract on offer: a "call option" giving the buyer a right to buy shares at a set price on a fixed future date; or a "put option" giving the buyer a right to sell shares at a specified price on a fixed date in the future.

A contract would cover "put" and "call" options on lots of 1,000 in the 68. Like the shares they shadow the price of a "put" or a "call" change daily.

So now for some recent examples of how "put" options could be put to work. Take Barclays Bank shares, currently trading a little over 720p. They have risen strongly from a low of 550p over the past year. This could prompt some investors to take out a "put" option to guarantee a minimum sale price. Currently buying a put option at 700p (that expires mid-June) would cost 14p for each Barclays share, effectively locking the sale price at 686p (700p less the cost of option, 14p). Locking in a sale price at 750p would cost 39p a share so the rock bottom price that the investor can expect per Barclays share is 711p, although don't forget about the other costs involved (see below). In the case of a "put" option the contract becomes worthless if at expiry the exercise price is below that prevailing on the shares in the stock market.

Take another good performing share over the past year - Zeneca. Shares in this drugs giant were changing hands around 1,340p last Thursday. They have risen from a low of 840p in the past year. Locking in at 1,300p would cost 16p per share so the minimum guaranteed price that investors can expect at the end of the term in mid-April is 1,284p per Zeneca share. The cost of a "put" contract over 1,000 shares would be pounds 160 (1,000 shares at the option price 16p) but there would be stockbrokers' commission (probably a minimum pounds 20 to pounds 25). Stockbrokers normally charge a nominal sum of pounds 1 to pounds 2 on top for arranging each option contract.

At any stage during the fixed term, right up to the day of expiry, the option can be sold, but investors would incur dealing costs. The other choice open to investors is to exercise the option to sell shares, although once again stockbroker dealing costs would be triggered.

The Liffe market is sometimes viewed as a gambler's paradise. But here it is providing a useful investor service that can prove to be highly relevant towards the end of a tax year - more so this year given the spectacular rise of the stock market.In effect it is providing what amounts to an insurance service for investors in these uncertain times.

For an explanatory booklet on the Liffe market and how options work telephone 0171-379 2486. Details are also available over the Internet. Liffe's web site address is http:\\www.liffe.com