Options may be traded on exchanges or over-the-counter markets. The option seller has to comply with the buyer's decision to exercise the option or not.
You may purchase a call option if you expect the price of a given security to exceed its exercise price (i.e., the price at which you would be entitled to purchase the stock, according to the option contract terms). In such a case, the seller is obligated to sell you the predetermined quantity of the underlying security at the predetermined exercise price. However, if the value of the security does not exceed its exercise price, you have the choice to waive your option; by doing so, you would realize a loss that is equivalent to the premium paid to purchase the option contract. If your option is negotiable, you could also resell it on a regulated market.
Conversely, you may purchase a put option if you expect the price of a security to drop below its exercise price.
Usually, there are two actions you may take when purchasing options: hope to resell them at a premium or exercise your right to purchase or sell securities. For instance, at the beginning of January, the stock of ABC inc. is trading at $25 and Peter believes that its value will go up. He buys 10 ABC call options at an exercise price of $25, which will expire in three months, in March. Each contract is for 100 shares of ABC. The price is $2.50 per contract ($2.50 x 100 x 10), for a total of $2,500, plus commission.
The market has played in Peter’s favour and in February, ABC shares are trading at $30. The option premium is now $5 per contract ($5 x 100 x 10 = $5,000). Peter now has the choice to: resell his options at a premium or exercise his options and purchase shares of ABC.
Since each contract is now worth $5 ($5,000 in total), he can immediately realize a 100% profit (before commission). If Peter chooses this solution, he is agreeing to waive his right to purchase these shares at $25 each.
To exercise his options and purchase shares of ABC, the seller of the 10 contracts is obligated to redeem 1,000 shares (10 purchase options x 100) of ABC at $25, even if their market value is now up to $30. The total acquisition cost would be $27,500 ($25,000 + the $2,500 premium to purchase the option contract). As a result, Peter has realized a gain of $2,500 (before commission), which is the difference between the total acquisition cost and the current market value of the security ($30,000 - $27,500).
The different types of options
Options differ based on the nature of the underlying security (stocks, futures, bonds) and certain features, such as returns, maturity and exercise conditions.
A call option gives the buyer the right – but not the obligation – to purchase a predetermined quantity of a security at a predetermined price, either at a specific date, in the case of a European-style option, or at any time, in the case of an American-style option.
A put option gives the buyer the right – but not the obligation – to sell a predetermined quantity of a security at a predetermined price, either at a specific date, in the case of a European-style option, or at any time, in the case of an American-style option.
The benefits of options
Options are versatile financial tools that provide both flexibility and growth potential.
Used wisely, they can reduce the risk of your portfolio and allow you to gain exposure to the stock market for a relatively low investment and as such, tap into considerable gain potential. Options are recognized for their powerful leverage.
Risks associated with options
When used for hedging, options have a very limited risk and can even help reduce the risk of your portfolio. However, when used for speculation, they carry a high level of risk, namely because of leverage.
To learn more about the different options strategies, we invite you to watch our introductory webinars.
Finding the right option for your situation
Finding the right option for your needs depends entirely on your strategy: are you looking to protect a certain position or speculate on a security?
Borrowing to purchase options
You can use a margin account to purchase options.
To learn more about margin accounts, please visit our dedicated brokerage account page.
With your National Bank Direct Brokerage account, it’s easy to trade options online.
- First, click on Transactions - Options and a transaction page will open.
- Select the transaction you wish to carry out and indicate the number of contracts you wish to purchase, the type of option (put or call), the underlying symbol, the exercise price and the market.
- Then click “Submit”.
- Verify the information to make sure you haven’t made any mistake, and click “Confirm”.
Once your order has been submitted, you may view it under Transactions – Current Orders and Instructions.
To make trading even easier, National Bank Direct Brokerage has also developed an Options Centre. By specifying the symbol of the underlying security in the appropriate space, you can gain access to all the options available, depending on their maturity dates.
Once you’ve selected the option that suits you, all you have to do is click “Trade” and a transaction ticket will instantly appear.
Finding an option’s market value
To help you find the option that’s right for you, National Bank Direct Brokerage has developed an Options Centre that is very easy to use.
Furthermore, under the “Chain View” tab, you can access all the quotes on a series of options available for trading. This tab shows you all of your put and call options, in addition to identifying those that are in the money.
Finally, under the News section of the Centre, you will find all the latest information about a given security.