– A stock option is simply a contract allowing the holder the buy a stock
(a “call” option) or sell a stock (a “put” option) at a specified price
(the “strike price”) within a given time. Purchasing an option is often
used by investors as “insurance” to protect a profitable position against a
drop in share price (put) option, or to acquire shares at set price, often
used during a bullish run, allowing the option holder to acquire shares at
a price lower than the prevailing market price.
Because an option represents a claim on the underlying stock, it has value
as an asset, and its price is referred to as the option “premium.” However,
this value gradually decreases as the option approaches its expiration
date. If the option isn’t exercised by the holder before the expiration
date, either to acquire (call) or to sell (put) the stock represented by
the specific contract, the value of the option drops to zero and it expires
worthless. Note that there’s no obligation to exercise the option contract.
The option contract simply represents the right to make a claim on the
The value of the option contract may be larger or smaller, depending on the
price of the underlying stock and the time left before expiration of the
Where things get interesting is that option contracts may be either bought
or sold (“written”) by investors. So, for example, when you “write” a call
option on shares you own (writing a “covered” call), you are in effect
offering the buyer of the contract the right to buy the shares of your
stock at a certain price within a certain time. For this right, the buyer
of your call option pays you the “premium,” which is determined by market
Portfolio managers frequently use the strategy of “writing covered call
options” to generate additional income on shares they believe are not
likely to move up significantly. The idea is that if the share price
remains below the strike price of the call option, the option will not be
exercised, and the investment portfolio adds the price of the premium
received to the net assets of the portfolio. If the price of the shares
rises to the strike price, the shares will be called away, and the stock
position will register a capital gain, plus the premium received. The
mirror of the covered call strategy is the put write strategy.
There are many permutations and combinations of these strategies, and things
can get quite complicated. Many fund sponsors now offer mutual funds and
ETFs that use sophisticated covered call or put write strategies as part of
the investment strategy their funds. For some, the option strategy is a
defining characteristic. For example, BMO ETFs,
Horizons ETFs, and
First Asset all offer a number of covered call or put write ETFs.
Option strategies definitely come with risks, and they aren’t necessarily
recommended for everyone. As a result, I strongly recommend you consult
with your financial advisor before using option strategies on your own
(especially if you are a novice) or before investing in a fund that uses
options as a core investment strategy. – Robyn
Robyn Thompson, CFP, CIM, FCSI, is the founder of
Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management
for high net worth individuals and families. Contact her directly by
phone at 416-828-7159, or by email at
for a confidential planning consultation.
Notes and Disclaimer
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The foregoing is for general information purposes only and is the opinion
of the writer. Securities mentioned are illustrative only and carry risk of
loss. No guarantee of investment performance is made or implied. It is not
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limitation, investment, financial, legal, accounting or tax advice. Please
contact the author to discuss your particular circumstances.