Unlike stocks and ETFs, options trading is an advanced investment strategy that allows seasoned traders to speculate on market volatility as well as lock in market gains and hedge losses.
Read on to find out how to trade options in Canada and whether or not this is an investment worth considering.
What Are Options?
An option is not stock itself, but rather, they are a derivative of a stock. This means that you’re trading an underlying security that is based on a stock’s trading price rather than the actual asset.
Options are more like speculating on which direction the price of the stock will move in. They are also a good way to protect against fluctuations in the market value of stocks as they allow investors to hedge losses if the trading price of the asset drops or set up a price “ceiling”—should the market value go over the strike price, the investor will still be able to cover the short position at the strike price.
How do options work in Canada?
Options are basically a contract between two parties—the buyer (or holder) and the seller (or writer). The contract states the holder has the right to buy or sell the underlying investment at a predetermined price at a given time in the future. To enter the contract, the holder pays a premium to the seller (i.e. the price of the option).
Options contracts are usually based on 100 shares of the underlying asset, so when you consider a quote for an options contract, multiply it by 100 to determine the market value. Thus, if an option has a premium of 35 cents/contract, one option will cost you $35 (0.35 times 100)
The options contract has three components:
- The option or obligation to purchase or sell the investment at a certain time in the future
- The strike price, i.e. the predetermined price the investment will be purchase or sold for
- The expiration date after which the contract has no value. The expiry date plays a crucial role in the value of the option—the less time there is until the contract expires, the less valuable the option becomes as the chances of the market moving in your favour increases with the more time available.
Unlike futures, though, with options you are not obligated to exercise the option, i.e. use your right to buy or sell the underlying asset at the predetermined date. Instead, you can let the option expire worthless, losing only the premium. Traders can also buy or sell an options contract before the expiry date if they believe they can make a profit or limit a loss.
However, if the holder exercises their right, the option writer must honour the conditions set out in the options agreement.
Types of options
The two main types of options are call and put options.
A call option gives the holder the right to buy 100 shares of the underlying asset at the strike price before or on the expiration date. The holder expects the value of the stock or ETF to rise.
If the stock price rises, the holder can sell the call option contract and profit from the price change without buying the asset. They could also exercise the option and buy the stock at a lower price than the market value. If the price decreases, the buyer can let the contract expire in which case they will only lose the premium.
The writer, on the other hand, expects the value of the underlying investment to go down or remain the same. The maximum profit for the writer is the premium they received for the contract. However, If the holder chooses to exercise the option to buy, the writer must sell the stock at the strike price, thereby incurring a loss.
A put option gives the holder the right to sell the underlying asset at the strike price before or on the expiration date set in the contract.
The holder expects the value of the underlying investment to decline. This way the holder is ensuring that they will make a profit either way—if the asset drops in value, they will exercise the option and sell the underlying at the higher strike price, but if it rises in value, they can keep the stock and let the option expire, losing only the premium in the process.
The writer expects the price of the underlying security to go up or stay the same. The maximum profit for the seller is the premium. Losses, though, can be very high and depend on how much the asset depreciates since if called to do so, the writer must buy the underlying investment at the strike price even if the market value of the stock has increased.
How to Trade Options in Canada
Now that you understand a bit more about how options work, let’s take a look at how to get started with options trading in Canada.
Find a platform that supports options trading
Luckily most of the best stock trading apps in Canada also support options trading—the thing is that, unlike stocks, you can’t simply start dealing in options. You first need to be approved for a margin account. Once that is done, you can move on to the next step.
How to pick the right platform for options trading?
When choosing an options trading platform, keep these factors in mind:
- Global coverage—look for an app that offers trading on Canadian and US markets.
- User-friendly UI—an intuitive dashboard and real-time updates should be among your top priorities
- Fees and commissions—choose brokers with a lower commission, as costs can add up, especially on smaller orders.
- Customer support and resources—due to the complexity of options trading, it is wise to look for a platform that provides education and guidance.
Where can you trade options in Canada?
Here is a quick overview of some of the top-rated investment platforms that support options trading in Canada.
|TD Direct Investing||
|Interactive Brokers Canada||
|CIBC Investor’s Edge||
||$6.95 + $1.25/contract||$0|
Choose a trading strategy
There are a few options trading strategies you can use, such as:
This strategy involves investors holding a long call since they expect the price of the underlying security to go up. Profits are unlimited and you can’t lose more than the premium.
Here investors are holding the asset expecting the price to go down. The risk is limited to the premium you paid and so is the reward.
This is used by investors who are selling a call option to generate income on a stock they already own. There are minimal risks involved, but by selling the asset before the expiry date, investors miss out on the chance to fully profit from the price rise.
Fund your account and start trading
Once everything is set up, you need to deposit money in your account (depending on what deposit methods are supported by the broker) and start trading.
Luckily, most platforms have step-by-step guides on how to place an options order, as well as live chat customer support to help you out with the technical details, so you should not have any issues.
Benefits and Drawbacks of Trading Options
Pros of options trading
There are several advantages to trading options, but only if you know what you’re doing. As mentioned above, this is an advanced investment strategy that is not suitable for novice traders.
You could buy options at a lower margin which boosts leveraging power.
For instance, if you want to buy 100 shares of a stock worth $80, it would cost you $8,000. However, if you were to buy two $20 calls, you would only pay $2,000 (2 contracts times 100 shares per contract multiplied by the market price of $20).
Options can be riskier than buying stocks, especially for beginners, due to their complex nature and the level of knowledge and experience one would need to successfully trade options.
That said, if used properly, options can mitigate losses and actually avoid risk. What’s more, the lower financial commitment makes them inherently less risky than shares. Options are also one of the most dependable forms of hedging losses—an investor can buy a put option, thereby protecting their assets.
Boost possible returns
Options can offer higher returns—the initial investment is lower than with stocks, while the gains are the same, so they can be more profitable overall.
For experienced investors, options open up a lot of avenues allowing you to develop your investing style. For example, investors who want to short a stock but are unable to do so because their broker either charges a high margin or doesn’t allow it can use options.
Cons of options trading
However, as with any other investment strategy, there are risks associated with options. These are some of the factors to consider.
Complex to understand
To learn options trading, you must have a thorough knowledge of the market. Otherwise, you run the risk of making a wrong decision and losing a lot of money.
An option is a wasting asset
When you buy common stocks you can hold them indefinitely and wait for the price to rise in order to sell. On the other hand, with options, you have a limited time to make a profit.
if an option expires it becomes worthless. What’s more, you need to know exactly when to sell—if the price of the underlying does not rise as much as anticipated before the expiration date and the holder lets the option expire, they will lose their investment.
High loss potential for sellers
Whether you are writing a call or put option, you face the risk of losses which are much greater than the income you will receive from the contract’s premium.
Not everyone can start trading
As mentioned above, most platforms that allow options trading in Canada require users to meet certain requirements before they can open a margin account.
Futures and stock trading have lower commissions than options. This, however, depends on the broker you use, so compare several to determine which one has the lowest fees, but offers value for money as well.
What is the difference between stocks and options?
One of the biggest differences between stocks and options is that when you buy stocks, you are technically purchasing a share in the company which gives you the right to dividend payments (if the company pays out dividends) and in some cases voting rights.
|Related: What are the best stocks to buy right now?|
On the other hand, with stocks, you only make a profit when the price of the shares goes up. With options, you have the chance to make a profit even when the price of the underlying declines.
Are options riskier than stocks?
Not necessarily, as both investments come with risks.
Options are not generally listed among safe investments due to their complexity and the advanced trading strategies involved, whereas stock trading is more basic and thus easier for novices to understand.
Nevertheless, options can pose less of a risk since the initial investment is lower, but only if executed correctly by someone who understands the market and can profit from price volatility.
If you are someone who understands the basic concepts behind options trading and is familiar with the risks of advanced options trading strategies, this can be a very profitable road to pursue.
However, if you don’t fully understand the potential risks involved when it comes to how to trade options in Canada or you are not experienced enough to monitor and react in time to changes in the market, it might be better to stick with less complex investment products.
If you are unsure whether options are the right call, try trading in a demo account—this way you will get a sense of the advantages and risks, without using any of your actual capital.
Not right now, although the platform has announced that they are getting ready to offer options trading. A specific timeline has not been confirmed yet.
Yes, options are traded on the Montréal Exchange, although most brokers give you access to US exchanges as well.
It is possible, but the CRA has strict rules when it comes to what qualifies as an investment with registered accounts like an RRSP or TFSA. You might want to talk to a tax professional or financial advisor before using your registered account for options trading.