Trading options may appear to be daunting at first, but the key to getting a head start is to have a well-defined objective and a financial plan that aligns with your unique goals.
Investing in equities through options can become more attainable when investors take a step-by-step approach and utilize an organized framework as outlined below to create long-term wealth.
1. Select a Trading Platform that Supports Options Trading
Interactive Brokers provides access to a wide range of markets in a low-cost fee structure. The platform is geared towards relatively sophisticated and active market participants.
- Low-cost execution for option trades and large global footprint.
- Pre-market capabilities help investors make discretionary decisions and get ahead of big market moves.
- Understanding their desktop platform may be difficult at first.
Questrade is a good balance between a free platform and a low-fee discount broker. This hybrid approach is broad-based and has enough appeal for both long-term investors and active traders.
- Questrade borrows features from both full-service and online discount brokers to bring the best of both worlds. Leveraged accounts and options trading capabilities are key strengths of this platform
- Easy to use investing platform and range of devices supported (desktop, mobile app) with seamless integration.
- Mobile app might be buggy and lags from time to time affecting execution.
CIBC offers a competitive platform with reasonable brokerage charges despite being a full-service broker and a large financial institution. It will be a good fit for customers that trade selectively and have more of a long-term investment horizon.
- Flat execution fees and discounted rates for students are strong points to trade with CIBC.
- Reduced fees for active traders and no account minimums.
- Customer service and support seems to be lacking a little bit.
It is important to keep the following points in mind while selecting an investment platform to trade options in Canada:
Execution Capabilities: Most brokers have good connectivity to US and Canadian equity markets but might lack execution in other markets such as Europe or Asia.
For active market participants chasing opportunities, it can be helpful to use a more global platform that enables quick execution in a reasonably priced manner.
Margin Account: A margin account is necessary to execute derivatives, especially writing options for generating income on long portfolios.
Transaction Costs and Charges: Most brokerages offer similar features and have fairly robust platforms, but charges vary based on the platform and how actively the investor trades with them.
2. Open a Margin Account
A margin account is a type of brokerage account that allows you to borrow from your broker to purchase additional securities.
The amount you can borrow is based on the current value of your investment portfolio.
The loan provided is called the margin amount and is subject to guidelines provided by the broker to identify marginable securities against which they’re willing to lend.
Margin accounts are non-registered accounts and are necessary to trade options from the short side.
3. Choose an Options Trading Strategy
Trading options requires a certain amount of sophistication and knowledge of derivatives to understand how option pricing and valuation work.
Here are a few investing or trading strategies that lend well to long-term investing.
Investors having long-only portfolios can benefit from selling covered calls at higher strikes to generate premium income for their portfolio.
This strategy has minimal risk as it augments the existing positioning while collecting some option premium.
However, if the strikes sold are close to the existing price, then the shares might get called away which may not be the desired outcome of using this strategy.
Cash Secured Puts
Investors that want to acquire a long-term portfolio can begin acquiring these shares by selling cash-secured puts on names they would like to own.
As a result, they can pinpoint the entry point for these companies and collect premiums as a result.
Their cost of acquisition will be the strike sold less the premium received.
A bit of sophistication is needed to exercise this strategy but works well if investors are disciplined and focused on building a long-term portfolio.
By combining the above two strategies, the investor can begin with cash-secured puts to acquire long term holdings and then implement selling covered calls on those holdings to collect premium.
Such a strategy is slow and steady without speculating more than necessary and has adequate market exposure but depends on the quality of companies acquired in the process as well.
4. Fund Your Account and Start Trading
Once an options trading strategy is chosen, investors can fund their brokerage account and initiate trades.
Most brokers have several methods to deposit funds and these vary from broker to broker.
Oftentimes, a bank wire or electronic transfer is the most reliable and cost-effective way to fund your account.
These transfers can take 2-3 business days to show up in your account and there are minimal to no additional costs to using this deposit method.
Another popular method is adding your broker as a payee under the bill payment section of your online banking app.
This provides a quick and timely deposit method with faster processing in some cases.
Once your funds are credited, you can now begin building your portfolio by placing trades.
To look up a particular option, you can search the underlying stock using the trade or quote section on your investing platform and locate the option chain showing the calls and puts trading with relevant strikes and the last traded price for the premium.
Once you’ve loaded the option based on strike and maturity, you’ll be able to view relevant trading information about the contract such as opening price, trading volume, high and low of the day and much more.
Upon analyzing the information, investors can place buy and sell orders using market or limit orders.
Market orders execute immediately based on the prevailing prices while limit orders will execute at the desired price levels (or below).
The option executed will show up as an open position with the cost of acquisition, quantity, and unrealized profit or loss on the position in the dashboard of the investing platform.
Frequently Asked Questions
- Can you trade options in Canada?
Yes, you can trade options through most Canadian brokerages.
- Is there a Canadian-specific options market?
Canadian equities and indices have an active options market with a reasonable degree of liquidity to execute trades. These are traded on the TSX and represent options for Canadian-listed names.
- Can I trade options in my TFSA?
Holding options in a TFSA is permitted if the intention behind placing such trades is long-term as opposed to active buying and selling. Trading actively in a TFSA, regardless of the instrument, is not permitted.