If you’re looking to increase your potential profits, options trading is worth considering.
Even though options have no value, unlike stocks and mutual funds, they derive from the value of underlying securities. This makes them cost-effective with high returns potential.
However, options tradings’ high commissions and less liquidity make them unstable to many investors.
As a Canadian investor, it’s essential to understand the ABC of options trading in Canada before venturing. This will help you minimize risks and maximize profits in the long run.
This article covers everything you need to know about options trading in Canada, including the best trading platforms and alternatives.
What is Options Trading?
Options are agreements that grant the holder the authority to sell or purchase an underlying security at a specific price on or before a predetermined date.
The options contract you purchase does not represent a stock. It means the right to exercise the option until the end of the contract.
Let’s easily explain what options trades are by using the analogy of renting a movie. “A stock option is like a movie ticket.
You pay a small fee for using the ticket, and you have the right to watch the movie. At the end of 3 hours or any point during that time, you may let someone else use your ticket.
If you choose to use your ticket to watch the movie, you must return it or purchase another one once it’s over.
The option writer/seller is obligated to fulfill the contract if both parties meet special conditions (the option’s strike price and expiration date).
Trading options are similar to trading stocks, but some distinct differences exist. When you purchase an options contract, you are betting on one of two things.
You believe that the underlying security price will move dramatically, either up or down, by the time the option expires.
The option buyer can either purchase or sell the at the strike price, exercising the options or selling the options to someone else.
For a stock to qualify for an option in Canada, it must be listed on a Canadian exchange, such as the Toronto Stock Exchange. Also, its market capitalization must fall within the top 25th percentile.
The two option types can be combined to create different options strategies for income generation, hedging portfolio risks, and speculation.
Types of Options Trading
An option’s duration can be determined by its expiration date. A short-term option expires within one year, while a long-term option has an expiration date over a year.
The cost of buying short-term options is generally lower than purchasing long-term ones.
In many cases, they are used to gain a competitive advantage by taking advantage of a material event involving the underlying asset.
However, since long-term options have a higher time value, the stock price can rise for a more extended period.
Investors often use long-term options to predict an increase in a stock’s price over time.
Advantages of Options Trading
There are a lot of benefits when it comes to options trading. Below are some of the advantages of options trading:
Cost-Efficient
Options are an efficient method to take advantage of market fluctuations and trade in the equities market.
A trader or investor can purchase an option while trading in the equity market at much lower margins than buying and holding stock.
High Return Potential
Options trading is a high-return potential form of stock investment. Options trading would be an excellent way to grow wealth.
An investor will only lose their investment if the option expires worthless, so it is possible to earn high returns with options trading even if there is a fall in the stock market.
More Strategy Available
The options market offers many more strategies for trading. You can use different options to create a strategic position in your portfolio.
Also, you can use them for trading directly and speculating on the direction of the price movements.
Lower Risk
When investors want to buy large stock positions, there are many risks associated with putting in a new position.
However, the investor can use options to protect their investment if the stock price declines by purchasing an option. In this way, the investor can control many more shares than they would afford.
Disadvantages of Options Trading
As discussed above, options trading can be advantageous, but there are a few disadvantages. Below are some of the drawbacks on options trading:
High Cost of Trading
The cost of options trading is generally higher than that of stock or futures trading. Traders can, however, trade on lower commissions with some discount brokers. Unfortunately, the fee for trading options is generally higher with full-service brokers.
Less Liquidity
Another disadvantage of trading options is their lower liquidity. Unlike the stock market, where you have thousands of investors buying or selling all simultaneously, options only a few, select buyers and sellers, hence the lower liquidity.
Limited Stock Options
Limited stock options trading means that you can only short sell or purchase stocks as options. Options are not available for all stocks listed with exchanges. Options strategies are made more difficult by this, making it hard to hedge a trader’s position.
Time Decay
Time Decay is the worst enemy of a trader who mainly trades options. It may reduce the initial premium by some percentage each day. Each day, no matter how much the underlying moves, the value of your option premium decreases.
How to Trade Options in Canada
Buying and trading options require a brokerage, just as with stocks. A brokerage account is more difficult to open because options trading is usually riskier than trading stocks.
A brokerage will often inquire about your trading history, earnings, and financial objectives. Despite this, it is still a pretty similar process to trading stocks.
As soon as you have your account set up and decide on what assets you want to trade, it is time to dive deep into the details.
Depending on what kind of option you choose, you will speculate on whether a stock’s price will rise or fall.
If you choose a call option, you’re betting that the stock’s price will rise and, therefore, choose to buy it at a higher rate at a determined future date.
Also, when you choose a put option, you predict that a stock’s price will fall and thus decide to sell shares at a certain price during a specific period.
Best Option Trading Platforms in Canada
It can be challenging to choose a brokerage platform since they all offer varying advantages, such as trading commissions, order types, research tools, and customer support.
However, some stand out from the crowd. Below are some of the best options trading platforms in Canada:
Questrade
Questrade is a full-service online brokerage that offers beginners and seasoned investors a self-directed investing platform.
This brokerage charges a commission of $9.95 + $1/contract on options trades. With an active trader’s subscription, options traders can access $4.95 + $0.75 per contract with advanced market data plans.
Investing tools from the company enable you to make smart decisions quickly and are easy to use.
Additionally, Questrade offers four different approval levels for options traders. Minimum balances are assigned to each level – the lower the level, the lower the minimum balance.
Interactive Brokers
Trading platforms offered by Interactive Brokers include Trader Workstation, Client Portal, and IBKR Mobile. Beginners should use the Interactive Brokers Client Portal or the app.
Using the website is very easy, and making a trade is straightforward.
In comparison to its competitors, it charges pretty low commissions. For trades less than 10,000 in a month, the price starts at $1.25 per contract with a minimum charge of $1.50 per order. Currently, the commission is:
- The fee is $1.15 per contract for trades between 10,000 and 50,000 each month
- The price per contract for 50,001-100,000 transactions per month is $1.05.
- If you trade more than 100,000 contracts per month, you will get $1 per contract.
Nevertheless, it costs $1.50 to start.
Scotia iTrade
Several trading platforms are available through Scotia iTrade: they include Scotia OnLine, Scotia iTrade Trading Desk, Scotia iTrade FlightDesk, and the Scotia iTrade mobile app. You should use Scotia OnLine and the app if you are a beginner.
Options trades are subject to a commission of $9.99 per trade plus $1.25 per contract. A commission of $4.99 per trade plus $1.25 per contract will be charged to those who make more than 150 trades each quarter. The commissions are the same for trading on American exchanges, but they are in U.S. dollars.
iTrade U offers investment education resources with no minimum investment requirement. No account is required. You can, however, open a practice account if you want to trade for free.
TD Direct Investing
Canada’s TD Direct Investing from TD Bank is another popular broker for options traders. It allows Canadian investors to trade securities listed on U.S. and Canadian exchanges through a feature-rich investing platform.
TD Direct Investing allows trading options through three integrated platforms: Advanced Dashboard, WebBroker, and the TD app.
US and Canadian options are generally traded at $9.98 + $1.25/contract. You must have executed at least 150 trades in the previous quarter to qualify for Active Trader pricing.
5 Factors to Consider When Choosing an Options Trading Platform
Consider these things below before choosing a brokerage in Canada for options trading:
1. Trading Commission
Before choosing an options trading platform, start with the essential factor, trading fees. Fees can drastically reduce profit margins, so you need to research this one.
2. Available Products
The availability of products is a non-negotiable aspect of a broker. Look for one that offers the types of options you want to trade, such as single-stock futures, index options, or LEAPs.
3. Account Balance
Minimum account balance requirements may apply to your options trading activity. Find out which brokers have a minimum requirement and the amount.
4. Margin Requirement
Stock traders need the funds to purchase the underlying share and pay trading fees to trade options. This is known as margin requirement; different brokers have different policies, so it’s best to clarify this before choosing a broker.
5. Order Types
When choosing an options trading platform, one of the first things to look at is the number of order types offered. Do you need options spreads? How about stop-limit orders or filling direct orders?
By having more order types, you will be able to manage your trades better, how they are filled, and at what price.
Options Trading Alternatives in Canada
The world of options trading requires a great deal of experience and knowledge. Although some strategies are relatively risk-free, and you won’t lose more than the premium you paid, other strategies pose a greater risk.
Trading on margin increases your risks. Hence, it should be left to more experienced traders or used to hedge basic portfolios.
However, some investors are better off passively investing instead of trading options using the following alternatives:
Self-Directed Investing
Using a self-directed account is a low-cost alternative to options trading. Investing this way involves opening a brokerage account, conducting research, and making trades.
Investors make all decisions regarding contributions, purchases, rebalancing, and other investments on their own.
In the past, self-directed investing was complicated, costly, and took a lot of time. Anyone can now quickly and easily build a diversified investment portfolio using ETFs.
With just a few ETFs, investors can gain exposure to many stocks within a specific sector, country, or asset class.
Better still, you can invest in multiple asset classes, sectors, and geographies with all-in-one ETFs.
Robo-Advisors
Through an automated investment platform, Robo-advisors provide their clients with investment advice. They do investment and portfolio management daily.
The client contributes to an account, and investment assets are allocated and risk profile based on their asset allocation and risk profile.
Robo-advisory services offer a variety of low-cost options to Canadians. One of the most popular platforms is Wealthsimple, which charges 0.5% annually.
RELATED: Day Trading in Canada
Conclusion
Options trading is a great way to make some extra money, so long as you know what you’re doing.
They are simply another way to trade stocks, and they’re used in many different ways by both novice investors and experts.
However, if you’re about to start trading options, it’s essential to have a basic understanding of stock trading.
Options trading can seem intimidating at first, but it turns out options are pretty simple.
This article has unlocked their secrets and shown you how to make money with options.
Hopefully, you understand the basics now and make some money with options trading in Canada.
FAQs
Can you trade options in Canada?
Yes. The Montreal Exchange is where Canadian options trading takes place. You can also trade options listed on Canadian and American exchanges through most online brokers.
Is options trading better than stocks?
Unlike stocks, options provide the most reliable hedge and are also the safest.
Can you trade options in a TFSA?
If your investments are qualified, you can hold options, stocks, and mutual funds, in your TFSA.
Can I buy options in RRSP?
Call options can be bought or sold by RRSP investors. However, you can only sell call options if you already own the underlying shares in your RRSP.
How are options taxed in Canada?
Capital gains are taxed on call and put options for most people. Nevertheless, if you profit or lose from the sale of stock, your gains or losses from options will be reported as income.
