Rbc Direct Investing Stock Options

Rbc direct investing stock options

Rbc direct investing stock options

Individual investors often shy away from options, seeing them as too risky or simply do not understand how they work.

Let’s take a closer look at what you need to know about options so you can determine whether they are a right fit for you and if they can help you reach your financial goals.

What are options?

Options are tied to an underlying asset and are sometimes called derivatives—because an option derives its value from something else.

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Options are most frequently linked to stocks but the underlying asset can be bonds, currency, interest rates, indices, ETFs, and futures contracts.

Options and stocks trade on an exchange and are often discussed together, but they are different in that while stocks give you a small piece of ownership in a company, options do not.

Instead, buying or selling calls and puts can give you exposure to the price movements of the underlying asset without actually owning the asset.

Below we’ll explain some common terms and trades to familiarize you with how options work.

Options Contract:

An options contract gives you the right to buy or sell a stock at a specific price by a specific date (the expiry date). There are always two sides of a trade - a “buyer” and a “seller” (also known as a “writer”).

Options contracts are usually based on 100 shares of the underlying stock.

(This is generally the case, unless the options have been adjusted for special events, such as a stock split or a special dividend.) For example, if the option on each unit of a given stock is trading at $1, the minimum value for a standard options contract would be $100 (100 units x $1) or $10 (10 units x $1) for a mini options contract.

RBC Direct Investing offers American-style options contracts which can be exercised at any time up to or on their expiry date.

These are the most common type of options and differ from European-style-options, which may only be exercised at the expiration date.

It should be noted that there are some nuances to the rules and exceptions to understand depending on the type of option you are looking at (Index Options are an example).

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Be sure to become familiar with the important details of any type of option you are interested in.

Premium:

This is the price you pay or receive for an options contract. An option’s premium is determined by several factors including the underlying security price, strike price, time remaining until expiration and volatility.

Strike Price (also known as the Exercise Price):

This is the price at which you can exercise the options contract.

Expiration Date:

Unlike purchasing stock, buying an options contract is generally a shorter term investment.

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When you buy or sell an options contract, you must agree to an expiration date, as part of that contract. This is the date at which the options contract expires.

As the buyer or seller of an option, you can choose which expiration cycle you would like to invest in.

For most stock options, there are typically quarterly cycles, monthly cycles, and weekly cycles. 

Exercise:

This means taking action on your options contract any time up to and including the expiry date (American style).

In-the-money:

If you’re long an options contract (the buyer), this term relates to the extent your options contract is profitable - the underlying stock price is either above the contract’s strike price (call option) or below the strike price (put option).

If you are short an options contract (the seller or writer) and the option is in the money, there is a high likelihood that the buyer would exercise and you’d likely be assigned.

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You would be obligated to either sell or buy the underlying stock which may be undesirable.

At-the-money

This means the strike price of an options contract and the stock price are the same.

Out-of-the-money:

If you are long an options contract (the buyer), this term relates to the extent your options contract is not profitable - the underlying stock price is either below the contract’s strike price (call option) or higher than the strike price (put option).

If you are short an options contract (the seller or writer) and the option is out of the money, there is a low likelihood that the buyer would exercise and you’d likely not be assigned.

Time Value:

An option's time value is equal to its premium (the cost of the option) minus its intrinsic value (the difference between the strike price and the price of the underlying asset).

Assignment:

If you are “assigned” it means that as an options writer you are obligated to fulfill your obligation to buy or sell the underlying stock at the strike price.

Generally, assignments can occur at any time but are more likely to happen when an option is expiring in-the-money.

Types of Options

There are two main classes of options - calls and puts.

Call Options

Investors will often purchase a call option on a stock as a way to participate in an anticipated rise in a stock’s price, without actually owning the stock. Another common strategy is called “covered call writing” where investors write a call on a stock they own to earn a little income and extra return on their stock position.

  • Buyer: When you buy a call option, you pay a "premium" to have the right—but not the obligation—to buy the underlying stock at a specific price (strike price) on or before a specific date (expiry date).
  • Seller: When you sell (write) a call option, you receive a "premium" but have the obligation to sell the underlying stock at a specific price (strike price) on or before a specific date (expiry date), should you be assigned.

Put Options

Investors will often purchase a put option on shares they already own to act as a hedge against the decline in the share price.  Another strategy might be to sell a put option if you thought the underlying security was going to rise, not fall and collect the premium as income.

  • Buyer: When you buy a put option, you pay a "premium" to have the right – but not the obligation - to sell the underlying stock at a specific price (strike price) on or before a specific date (expiry date).
  • Seller: When you sell (write) a put option, you receive a "premium" but have the obligation to buy the underlying stock at a specific price (strike price) on or before a specific date (expiry date), should you be assigned.

Let’s look at some common options scenarios (commission costs are not included in any calculations).

Example 1: Buying a call option

Let's assume you’re interested in buying Company ABC.

The company is currently trading at $10 and looks poised for growth.

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You believe the stock price is going to increase in the near term. Rather than buying the stock, you could purchase a call option, which would give you the right—but not the obligation—to purchase the stock if it increased in value above the strike price.

For example: You decide to buy one call option on ABC with a strike (exercise) price of $10.

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You pay a $1 premium (or $100) and the contract expires in three months (90 days).

Over the next three months, let’s say one of two possible scenarios occurs:

  1. As you anticipated, the stock price rises to $14. You may decide to exercise your option and buy the underlying stock at $10, or sell your contract for a profit (the contract is $4 “in-the-money” or above the strike price).

    If you choose to exercise, your total cost per share will be $11 (strike price of $10 + $1 premium paid, which means you’d be buying the stock at a $3 discount from it $14 market price.

  2. Instead of rising in value, the stock price actually falls to $9.

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    As a call option holder, you would choose not to exercise your option (buy the stock at $10) and let the option expire. Your maximum loss would be the $1 premium, or the $100 you paid to buy the options contract.

Example 2: Buying a put option

Let's assume you own shares of Company ABC. The company is currently trading at $10.

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Due to market news you believe the stock price is going to decrease in the near future. Rather than selling the stock now, you could purchase a put option, which would give you the right – but not the obligation – to sell the stock if it decreased in value.

For example: You decide to buy one put option on ABC with a strike (exercise) price of $10.

You pay a $1 premium (or $100) and the contract expires in three months (90 days).

Over the next three months, let’s say one of two possible scenarios occurs: 

  1. As you anticipated, the stock price declines to $6.

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    You may decide to exercise your option and sell the stock at $10, or sell your contract for a profit (the contract is $4 “in-the-money” or below the strike price). If you choose to exercise, your net proceeds per share will be $9 (strike price of $10 - $1 premium paid), which means you’d be selling the stock $3 higher that its $6 market price.

  2. Instead of declining in value, the stock price actually rises to $11. As a put holder, you would not exercise your option (to sell the stock at $10) and let the option expire.

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    Your maximum loss would be the $1 premium or the $100 you paid for the options contract.

Example 3: Write a covered call option

Let’s assume that you own 100 shares of ABC.

The stock is trading at $10 and you don’t anticipate much price movement over the next few months. You can use your holdings to generate income by writing (or selling) a call option contract.

For example: You decide to sell one call option on ABC with a strike (exercise) price of $10. You collect a $1 premium (or $100) and the contract expires in three months (90 days).

Over the next three months, let’s say one of two possible scenarios occurs:

  1. As expected, the stock price after three months is still $10.

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    As the call writer in this scenario, you’d get to keep the premium you received on the sale of the contract. The odds of assignment are very low as the holder of the call option would not likely exercise the option to buy the stock at $10 when it can be bought in the market for the same price. Your profit would be $1 per share or the $100 premium you received.

  2. Instead of staying flat, the stock price rises to $14 and the holder of the call option chooses to exercise it (buy the stock at $10).

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    As the call writer, you are now obligated to sell your shares (your shares are “called away”) at $10. The loss would be $3 per share or $300 (derived from $14 market price – [$10 sale price + $1 premium collected]).

Options commissions:

Orders placed using our online investing site or our mobile applications are $9.95 + $1.25 per contract ($6.95 + $1.25 per contract if you place 150 or more trades per quarter).

Learn more about our Commissions & Fees.  

Features to Consider

Options can offer flexibility and allow for a variety of profit and risk minimization strategies.

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For instance, stock options can provide you with the ability to: 

  • Protect stock holdings from a decline in market price
  • Create income from stable stock prices
  • Acquire stock at a price below the current price
  • Benefit from a stock price's rise or fall without necessarily buying and selling the stock itself
  • Generate income from an existing portfolio
  • Use leverage to grow your portfolio

But remember that there’s risk with any investment.

To learn more about options read Options - Risk vs. ReturnIf they are a right fit for you, you might consider options as part of your investment plan.

Want to add options to your portfolio?

You can apply for options trading on one of your existing accounts.

Visit the Forms & Agreements and download the applicable form:

Options Agreement Form for residents outside of Quebec, or Options Agreement Form for residents of Quebec.

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RBC Direct Investing Inc. and Royal Bank of Canada are separate corporate entities which are affiliated.

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RBC Direct Investing Inc. is a wholly owned subsidiary of Royal Bank of Canada and is a Member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund. Royal Bank of Canada and certain of its issuers are related to RBC Direct Investing Inc.

RBC Direct Investing Inc. does not provide investment advice or recommendations regarding the purchase or sale of any securities. Investors are responsible for their own investment decisions.

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