Not for the weak of heart or inexperienced investors, options trading. In essence, you are taking part in a more complicated kind of investing that involves making predictions about market prices, making contracts, and other complexity that you should become knowledgeable about before playing the options game.
Since they would be much better served using one of the Best ETFs in Canada to carry out a low-fee index investing plan, the average Canadian investor has no need to even look at options trading.
But, if you’ve already made up your mind to trade options, continue reading to learn more about the top Canadian options brokers, what exactly options trading is and how it functions, as well as real-world examples that will help you comprehend the ins and outs of Canadian options trading.
BEST OPTIONS BROKER IN CANADA COMPARISON
4.8 / 5
Costs for Trading Options
1 contract for every $9.50 minimum.
The best options broker in Canada. dependable internet platform with cutting-edge data streams.
4.6 / 5
Costs for Trading Options
$1.25 for each contract or $8.75 minimum.
The best broker in Canada overall. a little more expensive than Questrade for option trading, but with superior service
3.8 / 5
Costs for Trading Options
$1.25 for each contract or $9.95 minimum.
80+ Free ETF Trades, Big Bank Convenience, Mid Cost: Best Large Bank Brokerage
3.6 / 5
Costs for Trading Options
$1.25 for each contract, minimum $1.50.
Lowest trading costs – Ideal for professional traders that heavily rely on option trading and borrow money to invest
3.3 / 5
Costs for Trading Options
$1.25 per contract with no minimum.
Low fees, but a terrible trading platform with no mobile app and bad customer support, among other things
3.1 / 5
Costs for Trading Options
$1.25 for each contract or $9.99 minimum.
Excellent Convenience, Nice Platform, High Fees
2.9 / 5
Costs for Trading Options
$1.25 for each contract or $6.95 minimum.
A good platform, however it doesn’t have all the features that the other Canadian bank brokerages do.
For more information on how to quickly reduce account costs to zero, see our comprehensive analysis of Canadian online brokers.
You can choose to pay $10 in trading fees or $10 per month for IBKR’s unique fee structure.
Best Options Trading Platforms In Canada
Although there are some significant distinctions amongst trading platforms, they are all comparable in that they let investors to buy and sell stocks, options, bonds, and other financial instruments.
You may select the best options trading platform for your specific demands at a price you are willing to pay by being aware of these distinctions. Let’s examine their comparisons in more detail.
One of the best online brokerages in Canada is Questrade. It provides a risk-free method of investing in many different financial instruments, including options trading.
Your cost to trade options on Questrade will be a minimum of $9.95 and $1 per contact. Despite not being the most affordable choice available, you can rest easy knowing that Questrade provides top-notch customer service. This might be useful, especially if you’re just starting out in the world of options trading.
With web-based Questrade Trade, QuestMobile, Questrade Edge, and Questrade Global, you can complete transactions with Questrade.
Check out our complete Questrade review to learn more about the platforms, costs, and other topics.
We believe Qtrade to be Canada’s top broker for a variety of reasons. With Qtrade, buying and selling is simple, affordable, and the customer service is excellent.
Qtrade charges a competitive $8.75 minimum and $1.25 per contract for options trading. There are extra account fees, such the $25 quarterly account charge, but there are easy ways to avoid paying this price, like ensuring that two commission-generating trades were executed in the quarter before.
Web-based and mobile app trading are also available through Qtrade, and both are straightforward and simple to use. Also, it gives users access to a variety of research tools, which is quite helpful for individuals who are just getting started. Read the full Qtrade review to find out why it tops our list of Canada’s Best Brokers.
One of the top bank-owned brokers in Canada is BMO Investorline. Even though it might seem excellent, that simply isn’t good enough to come in first place on our list of Canada’s finest brokerages.
Having said that, if you are already a customer of BMO and like the ease of having everything in one location, BMO may be an excellent alternative for options trading.
When it comes to pricing, BMO Investorline follows the industry norm and costs a minimum of $9.95 + $1.25 each contract. There is a $25 quarterly fee, but if your non-registered account is $15,000 or more or your registered account is $25,000, it will be waived.
To make options trading as easy and plain as possible, BMO Investorline provides both a mobile app and a web-based platform. The BMO Investorline app receives favorable reviews on both the Google Play store and the App Store, in contrast to several other banking apps. Visit our BMO Investorline Review to learn more.
With its fractional trading option, Interactive Brokers (IBKR), a favorite among FOREX traders, provides a lower entry hurdle than some of the other options available.
The affordable price of IBKR is another factor that makes it a desirable option. Trading options will cost you a minimum of $1.50, and depending on the price tiers, each contract might cost you between $1 and $1.25.
Although the cheap fee options trading is a welcome benefit, the web-based interface is far from ideal. Despite this, both Google Play and the App store give the mobile app a respectable rating. Despite IBKR’s many advantages, we do not advise beginning options traders to use it. See why in our comprehensive Interactive Brokers review.
NATIONAL BANK DIRECT BROKERAGE
We must give National Bank Direct Brokerage (NBDB) credit for being the first Large Bank to provide customers with free brokerage accounts. This can be an easy approach to start your options trading career for individuals who are already NBDB clients.
Although NBDB does not charge a commission for trading options, there is a $6.25 minimum cost and a $1.25 per contract fee.
Although NBDB charges lower options trading costs than other brokerages, they make up the difference by adding a $100 yearly fee on accounts with balances under $100 or with fewer than five trades per month.
The lack of a mobile app for NBDB is another drawback, making it less practical for people who need to trade while on the road. In this thorough National Bank Direct Brokerage review, you can learn more about the advantages and disadvantages of NBDB.
TD DIRECT INVESTING
One of the most reputable financial institutions in Canada, TD has a solid history. You or someone you know most likely has a TD account for investing. Although TD offers options trading, it is undoubtedly not the most economical.
At a $9.99 minimum and $1.25 per contract, TD’s options trading is one of the most expensive ones available.
TD Direct Investing offers three different trading platforms. The TD app or TD WebBroker will be used by the majority of beginning options traders. They also provide a multitude of educational resources to aid investors in developing their knowledge and abilities. Visit our comprehensive TD Direct Investing review for more information.
CIBC INVESTOR’S EDGE
CIBC Investor’s Edge, a different Big Bank option, provides a variety of financial products at a cheaper cost than other Canadian Big Banks.
Despite this, it’s still not the ideal option for Canadian options trading—or any other trade, for that matter. A $100 account fee is assessed annually by CIBC Investor’s edge. If it provided outstanding service, which it does not, then this may make sense.
Regular trading accounts with CIBC Investor’s Edge will cost $6.95 plus $1.25 for each contact. The fee for active traders is $4.95 instead.
CIBC Investor’s Edge provides both web-based and mobile interfaces, both of which recently underwent updates. Users now have access to a greater variety of tools and information to aid in their decision-making. This can be highly advantageous, particularly when it comes to trading options. For additional information, read our CIBC Investor’s Edge review.
OPTION TRADING IN CANADA
You’ve found the best spot to go for a thorough overview of Canadian options trading.
You can discover all the information you need to build your first options contract in this guide. Everything from the definition of options trading to its more intricate and technical facets will be covered.
We’ll also discuss how to safeguard your portfolio from market volatility because this is unquestionably a more difficult sort of investing than the all-in-one ETFs and Canadian dividend stocks where most investors begin their trip.
Although one route for investors who wish to be more active and take higher risks is options trading, you should understand as much as you can before beginning. You must be informed of the hazards before investing in options because the great majority of traders lose money.
But if you’re prepared to devote the time necessary to learn how to trade options profitably, this is where you should begin if you want to diversify beyond index or dividend investments.
You will learn the benefits of buying put and call options as well as the differences between calls and puts in this Options Handbook for Canadians. We’ll examine option writing, covered call option writing, covered call option rolling, and whether put options can genuinely shield your portfolio from volatility.
Due to the perceived “zero sum game” nature of options (there are differing opinions on this), together with the tremendous influx of novice traders, smart money is being drawn to the asset class. These smart money investors, who often take a passive strategy and favor long-term index or dividend investments, are now participating in the option trading market.
The objective is to profit from the volatility and receive “free money” by effectively placing market bets.
The possible issue is that long-term investors just need to correctly predict which companies will increase in value.
Investors in options, however, must correctly execute two steps:
1) How much will a business be worth later on?
2) At what precise moment will it be worth that much?
WHAT ARE OPTIONS?
Options are contracts that, very simply expressed, allow the trader the right to purchase or sell a financial instrument, like stocks, for a specific price and for a specific amount of time. Given that they draw their value from an underlying asset, options are classified as financial derivatives.
Options, as their name suggests, allow a trader to choose whether to actually buy or sell within the term of a contract. It merely serves as a guarantee for the agreed-upon cost and delivery schedule.
A variety of financial products, including securities/stocks, ETFs, and indexes, are accessible with options.
What Is An Options Trading Platform?
Simply put, an options trading platform is a brokerage account that enables individual investors to engage in financial trading operations.
This implies that you might buy options on the same platform you use to buy and sell stocks, ETFs, and other financial products.
All brokerages are not like this. Consider the online brokerage Wealthsimple Trade, which does not yet provide options trading.
It’s also vital to keep in mind that trading options typically entails greater fees. The cost might be justified if you successfully complete a purchase throughout the term of your options contract. If unfavorable market conditions prevent you from making a purchase while your contract is in effect, that was money wasted.
THE BASICS: HOW CALL AND PUT OPTIONS WORK
First of all, keep in mind that there are typically two types of options: call options and put options.
These two flavors are very different from their distant cousin EMPLOYEE STOCK OPTIONS, which are financial instruments given to employees by firms. Employee stock options provide you the opportunity to buy corporate treasury shares directly from the company at a set price for a set amount of time (usually 2 years or thereabouts).
For the time being, we’ll concentrate on the more popular CALL option and PUT option forms of stock option trading.
Options are a relatively straightforward idea and, at the same time, a very complicated and adaptable tool for managing a portfolio. There are EXTREMELY risky option strategies as well as VERY conservative option strategies. Unfortunately, the riskier tactics receive more attention. There is simply not enough information and investor education on options available, as seen by the raised eyebrows and queries I receive every time I describe some straightforward option strategies to investors.
Let’s start by discussing call options. A “derivative” is a security “whose value is derived from the value of anything ELSE,” and options are a sort of derivative.
This means that even though you haven’t really purchased the stock when you buy a call option on it, the option’s value DOES relate to the value of the “underlying” stock. From this point on, I’ll skip the academic stuff and go directly to the meat of the matter.
A call option is the Choice to acquire a stock at a specified price and for a specified amount of time in the future.
This would be advantageous if you believed that the stock will increase in value.
The fact that call options give for some leverage (enabling you to boost your prospective returns) and also
The fact that call options offer you some leverage (enabling you to boost your potential returns) and also restrict your potential losses is also noteworthy.
Let’s look at a sample call option quote for the stock ABC, which is now trading for $50 on the stock market:
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|Option Type||Security||Expiry||Strike Price||Premium|
Reading right to left: For the security ABC, this quotation is for a CALL OPTION. In April, the option contract EXPIRES. The option holder may purchase shares of ABC at any moment up until the third Friday of April for the $55 STRIKE PRICE. The option holder would have to pay $2.50 each contract and share in order to get the right to do so.
There are definitely some peculiarities, and it’s not nearly as simple as a standard stock quote.
The fact that all options expire on the third Friday of the months listed is probably what stands out the most. It indicates that the option holder has until the third Friday of the month, inclusive, to exercise their option; otherwise, the option expires on the following Saturday.
The “strike price” is the second thing I want to draw attention to.
No matter what the stock’s price was at the time you bought this option contract, you would have the option to purchase 100 shares of ABC for $55 each.
It would be absurd to “exercise your option” and pay $55 for shares of ABC when they are currently only worth $50 on the open market. On the other hand, since that is the option you have purchased, if ABC was selling at $70 prior to April, you could still purchase it for $55. You can immediately see the benefit of that skill.
Finally, you’ll see that I mentioned 100 shares. A 100 share underlying stock is provided for each option contract. Hence, even if the premium ($2.50) represents the cost to purchase this call option contract, your investment will be $250 ($2.50 x 100 shares).
Fourth, an option contract is considered to be “IN-THE-MONEY” when the value of the underlying stock starts trading ABOVE the strike price. It is “AT-THE-MONEY” when the stock price reaches the strike price. Finally, the option is “OUT-OF-THE-MONEY” when the stock price is BELOW the strike price.
In financial jargon, option contracts might be employed as follows:
On ABC, I own an April 55 Call.
PRACTICAL EXAMPLES FOR CALL AND PUT OPTIONS
Now that the semantics are clear, let’s look at some scenarios of buying the aforementioned call option contract with three possible results:
- Stock increases
- Stock price decreases despite no change in pricing.
Scenario 1: ABC Goes Up To $60 Before The Expiry Date
The option contract becomes “in-the-money” in this scenario. It would make sense to exercise your option to acquire the shares for $55/share and then sell them right away for a $5/share gain because you could sell shares of ABC on the open market for $60/share.
Having said that, a lot of people simply sell the option contract rather than exercising their option. When the option contract is in the money, its price rises in lock-step with the value of the underlying stock. The option contract’s price will change as a result. If you exercised the option and subsequently sold the shares, you would receive the same return if you sold the option contract instead.
The Apr 55 Call will trade for very nearly $5 if ABC is trading at $60 per share. Remember, you only paid $2.50 for it, therefore if you sold the option, you would have made a $250 profit (you purchased the option contract for $2.50 and sold it for $5.00). If you did the math the hard way, it would look like this:
You paid $2.50 for the contract, which when multiplied by 100 shares becomes $250. (cost).
If you execute your option, you will pay $55 for 100 shares, or $5,000. (cost).
Next, you sell your shares right away for $60 per share, multiplied by 100 shares, for a total of $6,000. (proceed).
$6,000 – $5,500 – $250 = $250
So, it doesn’t make a difference how you complete the math.
Your gain is not as impressive when compared to the conventional way of holding stocks. Typically, if 100 shares of ABC are purchased for $50 each, they can be sold for $60 each when the value of the company increases.
(100 shares x $50/share) Your original outlay would have been $5,000.
(100 shares x $60 a share) Your sale would have generated $6,000 in revenue.
That’s it; no premium was paid for any contracts. You would have made $1,000 on $5,000, or 20%, profit.
But keep in mind that we have only examined the “rosy” side of things; you must also consider the possibilities of the numerous potential outcomes. So let’s carry that out!
Scenario 2: ABC Stays At $50 Up To The Expiry Date
The April 55 Call would be “out-of-the-money” in this scenario. By the expiration date, the option would have lost all of its value. The fact that there is a potential that ABC will reach the strike price the closer we go to the expiration date is the only reason it has any value at this moment. Actually, this is referred to as the TIME VALUE OF THE CHOICE.
Warning: Tangent Beginning…
Indeed, this is a nice time to segue into a discussion about option pricing. There are two elements that make up an option’s price:
- The Time Value of the Option
- The Intrinsic Value of the Option.
Calculating the option’s intrinsic value is not difficult at all. When the option is “in-the-money,” it is just the difference between the price of the underlying stock and the strike price. So, if ABC were $60, the option’s intrinsic value would be $5.
Just like that.
A little bit trickier is the Time Value of the Option.
The time value of the option is difficult to measure on its own, but it can be calculated using the difference between the cost of the option contract and the option’s intrinsic value. When ABC is trading at $60 per share and you own an Apr 55 Call on ABC, you know the intrinsic value is $5, making the time value $0.50 if the option contract is priced at $5.50.
The time value of the option would be $2.50 if you had purchased the Apr 55 Call contract on ABC at the moment ABC was in-the-money (that is, the strike price was the same as the share price). The time value of the option is determined by supply and demand for the contract based on the distance to the strike price and the time until expiration.
Returning to our example, the option contract will be worthless if ABC never increases (or, to put it another way, never reaches the strike price). That indicates that you have lost all of your money, including the $2.50 contract premium you paid.
As opposed to simply going out and purchasing the 100 shares at $50 each, then selling them for $50 each. (Well, I assume you would be out a few dollars for commissions, but for the sake of our example – let’s exclude commissions for now.) You spent $5,000 and got back $5,000. In this situation, your entire principal is still yours.
So, all of a sudden, doesn’t the universe of possibilities seem to be losing some of its appeal?
Scenario 3: ABC Goes Down To $40
You should be aware by now that the option contract will expire worthless regardless of what happens if ABC is not in the black by the expiration date. Hence, by purchasing the Call Option Contracts in this instance, you have still lost all of your money. If you purchase a call option contract, you can only lose all of your money, regardless of whether ABC gets delisted.
But, the investor who purchases 100 shares of ABC at $50 per share and subsequently sells them for $40 per share will have suffered a loss of $1,000 on their initial investment of $5,000, representing a 20% loss overall.
Although while a 20% loss seems better than a 100% loss, in this example the option contract holder only lost $250 as opposed to a $1,000 loss using the conventional technique. As a result, in this instance, the absolute loss is higher than with the conventional method.
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ARE CALLS, PUTS, AND HEDGING FOR YOU?
You have now seen the workings of call options, so let’s move on. I believe I have provided a fair analysis of how they might benefit (or hurt) an investment.
So, who purchases options?
There are basically two justifications for purchasing call option contracts.
1) Strong potential leverage — when a stock only needs to increase by 20% (in the example situation) in order to return 100% of your investment, that is unquestionably leverage, right?
2) Reduced risk – This may seem paradoxical given that you can lose all of your money, but keep in mind that the loss’s absolute value can be modest (in our example, the contract purchase’s $250 worth).
Theoretically, purchasing an option enables you to leverage your long position in a stock for a quick and significant gain if you believe that it will increase in value.
In truth, when you purchase a stock option call or put, you are actually paying a significant premium, especially during periods like this one where volatility is at its highest and is also represented in the VIX (which measures volatility expectations by measuring the premium rates on puts – if the VIX is high it means that put premiums are high). As of right now, taking large bets will be highly expensive, and even if buying options would limit your loss, you still have a spread to beat.
This idea is best explained with the aid of an illustration.
Examining June 20, 2020 for SPY (SPDR S&P 500 ETF). Let’s assume you believe the market will decline by January 15, 2021. Perhaps you’re making a speculative bet or trying to safeguard your long portfolio by placing a wager in the opposite direction.
You anticipate a significant 20% decrease to 277 from the current SPOT for SPY of 308 (exactly 10% of the SPX). You then purchase put options with a 277 strike date for January 15, 2020.
You will pay $17.56 for a single option, and $1,756 for a contract with 100 options. Hence, you won’t begin to profit until SPY falls below 260 points (after deducting the spread cost from the actual strike). A single contract won’t be able to protect much of your portfolio, even if that were to happen.
Even in the most extreme situation, where SPY drops to 240, that contract will only result in a $2,000 profit (or a $3,756 total return, including your starting outlay).
Because you’ll be investing a substantial portion of your capital at risk with that alternative, the idea of a cap or limited loss is nullified if you want to preserve a sizable portfolio.
Consequently, the conclusion is that if you were to buy put options to hedge your portfolio or a specific investment, you should do it before everyone else is doing it and every other headline on the television is speculating where the stock market is headed. This is because at that point, premiums will be at their absolute PEAK, rendering your so-called “insurance options” completely useless.
OPTIONS SELLING / WRITING
You should be aware that investors might also choose to SELL call options.
Call option writing is the term used to describe this practice. In this scenario, selling the contract and receiving the premium (as opposed to BUYING the contract and PAYING the premium).
You would be required to sell your shares to the option buyer since they would have the option to purchase them before the option expired. The contract expires worthless to the option holder if the stock never hits the strike price (although you will have kept the premium regardless of what happens and still own the shares in the case of a “covered” call write).
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COVERED CALL WRITING
One especially intriguing usage for covered call writing as opposed to buying is:
Setting a “limit sell order” in this manner is an alternative.
You can just WRITE or SELL a call option and earn some extra money (the price you get for the contract) instead of telling your broker to sell when your stock reaches a certain level. Again: wonderful if you were intending to set a limit sell order instead. When the stock reaches the strike price, the option holder will exercise their right to acquire the shares and you will be obliged to sell.
When it comes to using options, this is perhaps the most popular “entry point” for the typical investor.
For instance, you might tell your broker (or trading platform) to execute a sale automatically at $60 if you purchased a stock for $50 and decided to sell it when/if it reaches $60. In that situation, your gain would have been 20% ($10 gain on a $50 investment, commissions excluded).
Yet, if you paid $50 for the stock and instead WROTE a call option with a $60 strike price and sold that contract for $2.50, presuming the value increased to $60, the option holder would exercise their right to buy at $60 and you would be compelled to sell.
You will have made a total gain of $25 as opposed to 20% because you will have received the $2.50 premium from selling the option contract AND the $10 gain from the shares. A 5% increase in profit, with the only new risk being missing out on a stock that is rapidly increasing (which you would have anyway if you had a sell order in place).
In fact, if the call option expires before reaching the stock price, the gain might even be bigger. If that were the case, you would continue writing calls options continuously and keeping the premiums for yourself. Your gain would be 30% if the second call option you wrote were to be exercised ($10 gain from the stock plus [2 x $2.50 per contract]).
Many investors simply keep writing covered calls and repeatedly receiving the premiums.
After a contract expires, they immediately write a new one. You would have received not just the substantial dividend from BCE’s shares but also the continuous premiums for many expired call option contracts that you repeatedly wrote if you had used this technique to BCE over the previous five years (prior to the run-up) (since the stock was essentially flat for 5 years).
It’s known as “COVERED Call Writing.” “Covered” denotes ownership of the stock.
Naked call writing is what it would be if you did not own the stock. Because you will be obliged to sell shares at the strike price (by short selling, as in The Big Short), and then cover your short at a higher stock price, naked call writing might be a significantly riskier investment.
Let’s examine a Naked Call Writing illustration:
You choose to write a naked call option contract with a $54 strike price and a $2 option premium that expires in four months even though you do not own ABC, which is currently trading at $50. Without investing any of your own money, you will have kept the $2 if ABC doesn’t reach $54 in the following four months.
BUT suppose ABC suddenly increases to $60.
You must sell ABC to the option holder at $54 per share in this scenario if they choose to exercise their right to purchase ABC at that price. You will have to purchase ABC on the open market for $60 a share in order to deliver the shares. As a result, you lost $6 on your purchase of $60 and sold it for $54. Your loss is now $4 instead of $6 since you still received $2 for first selling the option contract.
This example shows how severe your losses might be if the stock swings dramatically.
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HOW TO WRITE A COVERED CALL OPTION IN PRACTICE
Assume for the moment that you are willing to write a call option against an equity that you own.
The steps you would take are as follows:
Choose the stock or ETF you want to write a call on in step 1.
2) Go through the options list.
The third Friday of each month is when options expire, and there are continually changing “betting lines” as to what the value of that stock or ETF will be on that day.
Three) Choose a striking price. The price at which you are prepared to sell your stocks is known as the strike price. You are willing to sell your stock or exchange-traded fund for $50 if the buyer gives you a premium of $$$ if you sell a call for $50.
4) If the stock is worth more than $50 on that day, you will be required to sell it for $50; nevertheless, you will still be entitled to your premium.
No stocks exchange hands and you walk away with your premium if it is worth less than $50.
5) Keep in mind that each contract is equivalent to 100 shares of the underlying stock.
6) Choose “Sell to Open” under Transaction type. Simply put, you are selling your right to take the position. You select “buy to close” if you want to repurchase the option that you sold or any other option that is “long.”
THE EQUITY COLLAR – ANOTHER RISK REDUCTION OPTIONS STRATEGY
Derivatives are mostly used for speculating and hedging purposes. Hedging reduces risk, but speculating involves taking on risk.
There are several levels of each of the two major options trading categories.
The Equity Collar is a hedging tactic that aims to lower risk.
I might begin with an investor profile to help with understanding before introducing the approach as a resolution to her issue. Consider 64-year-old Sally, who has built up a significant portfolio that is entirely invested in an ETF that monitors the entire stock market.
Assume that the current price of the stock market is 10,000 and that each unit of the ETF is worth $100. Sally is unsure if we have reached a bottom in the markets or if there is still more decline to come.
She hopes to leave her job at the end of this year (nine months from now). When that happens, she has made the decision to alter her portfolio to one that is 50% fixed income and 50% equities. She has 5,000 shares of the ETF, giving her portfolio a total market value of $500,000.
With the current market pullback, she is convinced that if we are at a bottom, the market will have a good year and close at perhaps 10,800 points, or up 8%. She is nine months away from retirement, so she is aware that the markets could decline much worse in the near future. If that were to happen, she would not want to further deplete her retirement assets.
She may purchase a put option on the ETF with a $100 strike price if she wanted to safeguard her capital (or insure it against additional losses). Sally has the option to sell her ETF shares at the strike price of $100 per unit up until the option contract expires, but she is under no obligation to do so. As a result, she is now shielded from portfolio losses through the option’s expiration date (which in her case would be 9 months from now).
So, her ETF units would have decreased from $100/unit to $92/unit at the end of the year if the market had fallen from 10,000 down to 9,200 (a loss of 8%). Sally might, however, use her option to sell her units for $100 each. She thus took measures to protect her investment portfolio.
Of course, there is a cost associated with insurance, as with any service – which I haven’t mentioned yet. Assume that the put options cost $2 per share to purchase. In this scenario, the investor would need to purchase 50 put option contracts (each option contract represents 100 shares) in order to fully insure her $500,000 portfolio. She would have to pay a total of $10,000 ($2/share x 5000 shares). If you account for this expense, your portfolio is actually guaranteed not to go below $490,000 because you would always be responsible for the $10,000 expense.
This insurance premium may be too expensive for some people, and they may want to find a means to lower or do away with it entirely. Sally may earn $1.50 per share from the selling of a call option if she were to turn around and SELL it for a strike price of $110 (providing someone ELSE the right but not the duty to purchase her units). A covered call is what you would write in this situation.
She would earn $7,500 in premiums ($1.50/share x 5000 shares) if she wrote (sold) 50 call option contracts with a strike price of $110/unit. This might be utilized as a counterbalance to the $10,000 put option buy, resulting in a net cost to Sally of $2,500 as opposed to $10,000.
The trade-off is that the call option holder would exercise their right to purchase Sally’s shares once they rose beyond $110 a unit, limiting her portfolio gain to no more than 10%.
What happens in the end?
By the time Sally retires, she will have between $497,500 and $547,500.
Her outlay for that assurance was $2,500.
She has set a maximum gain of 9.5% for herself while protecting her portfolio from a gain of no more than 0.50%.
If Sally lowers the strike price on the call options she sells to maybe $108, it is possible to totally offset the premiums of the bought put options with the premiums of the sold call options.
In this situation, she can sell the call options for a higher premium of $2 per share, fully covering the cost of the put options. In this scenario, her portfolio would be restricted to a range of $5000 and $540 (with a guaranteed return of 0%–8%). But once more, Sally is giving up even more potential for her portfolio’s gains.
The Equity Collar is a financial instrument that involves simultaneously buying a put option and selling a covered call option.
OPTIONS TRADING IN CANADA – FAQ
Options trading is a financial tool that enables investors to make contracts to opportunistically buy or sell equities by a particular date for a particular time.
Although options trading does give investors a way to diversify their holdings, it does include some dangers, just like any other kind of investment. While generating gains can happen quickly, losing money can also happen quickly.
Is options trading the same as day trading?
Buying and selling securities on the same day is known as day trading. Just one-day options contracts can be made. Hence, it would be regarded as day trading in this instance.
BOTTOM LINE ON OPTIONS TRADING IN CANADA
Options offer the potential for enormous portfolio leverage.
It allows “intelligent investors” to protect against losses or, regrettably, raise the risk of speculation (compared to stocks and ETFs).
Selling covered options in particular is a reliable method of collecting premiums at a manageable risk (as long as they are COVERED). Options are a potent instrument in the proper hands. They are widely used by large financial institutions, which can witness to their usefulness as a derivative. These institutions are full of math PhDs.
Again, we don’t think the typical Canadian should invest in options. But, if you have decided to test the waters, be sure to familiarize yourself with your Canadian options trading platform and the accompanying pricing structure.
In our comprehensive review, learn in detail what the Top Canadian Online Brokers have to offer in terms of day trading and more. Our tutorial on How to Purchase Stocks in Canada is an excellent place to start if you are just beginning your investment journey.
FT and Canadian financial author and fintech entrepreneur Preet Banerjee are among the writers who have contributed to MDJ.