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What is Options trading?
Options trading is the purchase or sale of a contract of an underlying security. Investors can trade options to potentially benefit in any market condition.
But what are options? An option is a contract between two parties that gives the holder the right, without the obligation, to buy or sell a security during a designated time period at a specified price. Option writer has the obligation to fulfil their part of the contract if exercised.
There are many strategies investors can use in options trading, each with their own benefits and risks.
Benefits of Options
Things to consider
There are many things to be aware of when trading options. An important consideration to keep in mind is that the option seller (writer) can incur losses greater than the price of the contract. Consider each option strategy itemized below and the risks associated with it. Additionally, if the contract is not acted upon within the expiry date, it simply expires, and the premium paid to buy the option is forfeited by the seller. Note, TD Direct Investing automatically exercises options that are in-the-money for $0.01 or more.
Variable degree of risk
Transactions in options carry a high degree of risk. Purchasers and sellers of options should be familiar with the option type (call vs put) they contemplate trading and the associated risks.1
|
Description |
Option strategy benefits |
Option strategy risks |
|
|---|---|---|---|
|
Long Call |
In this options strategy, the holder of a Long Call has the right to purchase the underlying security at the exercise2 price at any time prior to expiration. |
This strategy has unlimited upside potential. |
The risk is limited to the price paid for the option contract or the premium paid for buying the Long Call. |
|
Long Put |
The holder of a Long Put Option has the right to sell the underlying security at the exercise price at any time prior to expiration. |
The benefit is limited to the strike price3 minus the premium. |
The risk is limited to the price paid for the option contract or the premium paid for buying the Long Put Option. |
|
Covered Call Write |
In a Covered Call Write, the writer buys the underlying stock and writes calls against the holding. |
Additional income can be earned by selling the call option against the stock. |
Risk can occur when the market price of the underlying stock falls. |
Variable degree of risk
Transactions in options carry a high degree of risk. Purchasers and sellers of options should be familiar with the option type (call vs put) they contemplate trading and the associated risks.1
|
Description |
Benefit of strategy |
Strategy risk |
|
|---|---|---|---|
|
Bull4 Call Spread |
This strategy combines a long lower strike call and a short higher strike call with the same expiration. |
The benefit is limited to the difference between the two call strikes minus the premium. |
Risk is limited to the net debit, or the premium paid for the spread. |
|
Bear5 Put Spread |
The Bear Put Spread combines a long higher strike put and a short lower strike put with the same expiration. |
The benefit is limited to the difference between the two put strikes minus the premium. |
Risk is limited to the net debit, or the premium paid for the spread. |
|
Bear Call Spread |
This strategy combines a long higher strike call and a short6 lower strike call with the same expiration. |
Limited to the net credit or premium received for the spread. The bigger the difference between the strikes, the bigger the potential profit. |
Risk is limited to the difference between the two call strikes. The bigger the difference, the greater the risk. |
|
Bull Put Spread |
This strategy combines a long lower strike put and short higher strike put with the same expiration. |
The benefit is limited to the net credit, or the premium received for the spread. |
Risk is limited to the difference between the two put strikes. The bigger the difference, the greater the risk. |
|
Calendar Spread |
The Calendar Spread has the same strikes with different expirations, using either both calls or both puts. Long back month and short front month. |
The premium received from the short option minus the profit from selling the long option after the front month expires worthless. |
Risk is limited to the net debit, or the premium paid for the spread. |
|
Long7 Combination/ Straddle |
This high volatility strategy combines a long call and a long put at the same strike (straddle) or different strikes (combination) at the same expiration. |
The benefit is potentially unlimited. |
The risk is limited to the cost of the straddle or combination. |
Variable degree of risk
Transactions in options carry a high degree of risk. Purchasers and sellers of options should be familiar with the option type (call vs put) they contemplate trading and the associated risks.1
|
Description |
Option strategy benefits |
Option strategy risks |
|
|---|---|---|---|
|
Short Call |
This income strategy involves selling/ writing a call option Uncovered or Naked8. |
Potential profit is limited to the premium received when writing the call. |
Risk is unlimited, as the market price can potentially rise indefinitely above the strike. This can also be affected by margin requirements.9 |
|
Short Put |
In the Short Put, an investor sells/ writes a put option Uncovered or Naked. |
Potential profit is limited to the premium received when writing the put. |
Risk is limited to the strike price minus the premium. |
|
Short Combination/ Straddle |
A short call and a short put at the same strike (straddle) or different strikes (combination) with the same expiration. |
Profit potential is limited to the premium collected for writing the straddle or combination. |
The Short Combination/ Straddle has unlimited risk. |
Are Options right for me?
Options may be considered by an investor who:
- Understands the underlying concepts of options trading
- Understands the advantages as well as the risks of a chosen investment strategy
- Knows how to manage a portfolio when reacting to changes in the market
Discover more about Options
TD Direct Investing invites you to join us in a series of events to help enhance your understanding of options trading. All investors are welcome, whether you are an experienced options trader or simply want to get started, there's something for everyone. Webinars, Master Classes and Videos. See the calendar of events.
Options are contracts that give buyers the right, but not the obligation, to buy or sell an underlying asset at an agreed-upon price and date. When you trade options, you’re essentially speculating on future price movement of the underlying security i.e., whether a stock will decrease, increase or remain the same in value, time period in which these changes will happen and extent to which it will deviate from its current price. Investors, generally, consider these parameters, to decide whether or not to enter into a contract to buy or sell a company’s stock.
Yes, if you are interested in trading options, you can apply at TD Direct Investing for approval once you become a client.
As a holder, you can choose to sell the contract at the current market value (ideally at a profit) or allow the option contract to expire worthless.
A put option is a contract or a derivative instrument in financial markets that entitles the owner to sell a specific security, usually a stock, by a set date at a set price to the writer of the put. A call option, which is opposite of put option, is a contract that entitles the owner the right, but not the obligation, to buy usually a stock, bond, commodity or other asset at set price before a set date. In both cases, the owner can either exercise the contract or allow it to expire, hence the term “option.”
Visit the TD Direct Investing Learning Centre today for more Options-related content.
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