Options are a type of financial derivative that lets you bet on how much a stock will move and over what time frame — not just whether it goes up or down. They're complicated, sure, but they give you more ways to profit (or hedge) than simply buying stock. This guide covers what options are, how they work, the key terms you need, and the risks to watch for in Canada.
What are options?
An option is a contract that gives you the right — but not the obligation — to buy or sell a stock at a set price by a set date.
But there's so much that can happen before that date. Most options are exchange-traded (as opposed to over the counter (OTC)). They trade on markets, like securities do, which means you can sell the option itself at any point until it expires.
Say $PEAR is trading at $150, and you think it's going to go up. You buy an option that gives you the right to buy $PEAR at $170 within two months.
Two months later, $PEAR hits $180. You "exercise" your option to buy at $170 and then immediately sell at $180 for a $10/share profit.
Anoptions contract represents 100 shares, but the premium (the cost to purchase the contract) is quoted per share. In this example:
Premium paid: $5 per share × 100 shares = $500.
Profit on exercise: $10 per share × 100 shares = $1,000.
Profit (before any fees or commissions): $1,000 − $500 = $500.
For comparison, if you had purchased $500 worth of $PEAR shares at $150 (about 3.3 shares) directly, and then sold them when the price rose to $180, your profit would have been about $100.
You don't have to wait until expiry either. For example, if $PEAR hits $165 a week later, you could potentially sell the option for a premium and earn more than you paid.
In a worse case scenario, if $PEAR stays below $170, you could sell the option for a loss to try to recoup some of your investment. However, if you hold the contract until expiry you will lose your entire $500 premium in addition to any fees and commissions that you paid.
What are the different types of options?
There are two main types of options:
Call options: give you the right to buy a stock at a set price (the strike price) and are typically used when you expect the stock price to rise.
Put options: give you the right to sell a stock at a set price and are typically used when you expect the stock price to fall.
The most common types of underlying assets in an options contract are single stocks (tied to individual companies) and exchange-traded funds (ETFs) (tied to groups of stocks).
What options terms should you know before you trade?
Before you make a trade, you need to know the lingo. Here are the standard terms you will see on any options chain:
Strike price: the agreed-upon price at which you can buy (for a call) or sell (for a put) the underlying stock.
Premium: the current market price of the options contract. It is what you pay to buy the option, or what you receive if you sell it.
Expiry (expiration) date: the exact date the contract expires. If you do not act before this date, the option either executes automatically (if it is profitable) or expires worthless.
In the money: when an option has intrinsic value. For a call, this means the stock price is higher than the strike price. For a put, the stock price is lower than the strike price.
Out of the money: when an option has no intrinsic value. If it expires out of the money, it becomes worthless.
Here’s a glossary of options terms for more.
Why would you buy an option?
You want to hedge your risk. Say you own a lot of $PEAR stock and you're worried the price could fall. Buying a put option could help to limit losses if that happens.
You want to get more exposure without spending a lot of money. Buying options can be a lot cheaper than buying corresponding stock outright, and the leverage provides a much higher potential upside.
You have studied the market and want to test your theories. Options can be used to express a view on both the size of a potential move and the time period in which it may happen.
How does options trading work?
Trading options is different from buying stock. With stock, you own a piece of a company. With options, you're buying a contract that gives you a specific right for a limited time.
Most contracts represent 100 shares, so a $2 premium actually costs $200 per contract.
Once you own an option, you have three choices:
Sell it before expiry to another investor.
Exercise it to buy or sell the underlying shares.
Let it expire. If it is out of the money, it expires worthless; if it is in the money, it is typically auto-exercised (subject to your broker's policies and available funds).
What happens after you buy an option?
You can sell or exercise your option anytime before expiry. What you get depends on the stock price at the time. Back to the $PEAR example:
If $PEAR falls below the strike price ($170), you could try to sell the option but will most likely get less than your $500 premium. If $PEAR soars above the strike price near expiry, you could probably sell the contract for a much higher premium than the $500 you paid.
You could wait until expiry. If $PEAR is above your breakeven price of $175 ($170 strike + $5 premium), you potentially earn a profit. Below $175, you lose some or all of your $500.
Even if $PEAR reaches $172 (in the money by $2/share), you'd still be down overall because you paid $5/share for the option, in addition to any fees and commissions.
When can you exercise an option?
You can exercise options anytime (if you have the cash for calls or shares for puts). If you wait until expiry, in-the-money options will generally auto-exercise.
Exercising early will depend on the situation. If the option is out of the money, you can exercise early to lock in or limit your losses. If it’s in the money and you exercise early, you could miss out on potential further gains.
At expiry:
In the money: the option is usually auto-exercised and you need to have enough cash (or margin availability) to cover the transaction. If you don’t, you could experience a margin call or the broker may sell the contract on your behalf before the market closes.
Out of the money: it expires worthless, and you lose the premium, plus any fees or commissions that you paid.
What drives the price of an options contract?
Like any other market, it depends what people are willing to pay. Figuring that out can be complex, but option prices are often explained using three main components:
Intrinsic value: how close the stock is to the strike price. If $PEAR is at $168 and your strike is $170, the option is worth more than if $PEAR were at $120.
Volatility: how much the stock bounces around. A steady stock is less likely to hit your strike price than a volatile one (think bumblebee vs. mountain climber).
Time value: how long until expiry. More time means more chances for the stock to move in your favour.
The specific metrics for pricing options are called "the Greeks." You'll see them listed with every options contract, and how they are calculated can be quite technical.
What are the risks of options?
All investments involve risk. One key risk in options trading is that if an option expires out of the money and you do not close the position beforehand, you can lose the entire premium you paid (plus any fees or commissions). With stocks, losses are usually not total unless the company's shares fall to (or near) zero.
Here's why options are riskier:
Compound volatility. Options prices depend on stock prices, which depend on company performance. Option prices are influenced by the underlying share price and by market expectations (such as expected volatility), which can add an extra layer of uncertainty. If market perception of volatility drops, your option can plummet even if the stock price stays flat.
Time sensitivity. Unlike stocks, options expire. As expiry approaches, out-of-the-money options lose value fast.
Confusion. Options can be complex, and common mistakes (such as misunderstanding contract size, expiry, or assignment rules) can lead to larger-than-expected losses, particularly with short-dated contracts.
Variable liquidity. There are way more options contracts than listed stocks. Some have few buyers, meaning you might pay more to enter or get less to exit.
Options trading in Canada: legality, accounts and permissions
Options trading is legal in Canada, but the rules depend on your account type.
Non-registered (margin) accounts: you can trade most options strategies if you meet brokerage requirements.
Registered accounts such as a Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP): the Canada Revenue Agency (CRA) restricts you to lower-risk strategies like buying calls/puts or selling covered calls. Naked options and complex spreads are usually banned.
Frequently asked questions about options trading
How does options trading work?
You buy or sell options contracts that reference an underlying asset. Your outcome typically depends on the premium you pay/receive, how the underlying price changes, and how much time is left before expiry (you can often close the position before expiry).
Why do so many option traders lose money?
Options expire, and if the stock doesn't move as expected in time, the contract becomes worthless — a 100% loss. Unlike stocks, you can't just hold and wait.
Is options trading legal in Canada?
Yes. Availability depends on your broker's approval process and the account type. Registered accounts such as a Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP) typically allow only certain lower risk strategies (for example, buying calls/puts and covered calls).
Can you trade options with $100?
Yes, but cheap options are usually far out of the money or near expiry, making them extremely risky with little room for strategy.
What happens if you do nothing until expiry?
Out of the money: the contract expires worthless, and you lose the premium plus any fees or commissions. In the money: the contract auto-exercises — you need to have enough cash to buy or stock to sell.
