Personal Investor: How options can fit into your RRSP and TFSA
You can hold just about anything in a registered retirement savings plan and tax free savings account. Yet, many investors limit themselves to stocks and bonds without even considering how options can smooth out volatility and generate income.
The options market can be intimidating but there’s one strategy tailor-made for long term investors wanting to generate some cash while waiting for a particular stock to rise. It’s referred to as covered call writing. It’s covered because the security is owned, not borrowed (the term for a borrowed security is “naked” but that’s a whole other thing).
A call gives an investor the right, but not the obligation, to buy a security at a specified price within a specific time period. If you are writing a covered call, you are selling that option to the market.
Think of it as renting out a security for a premium – with a twist. If the value of that security rises to a predetermined level – called a strike price, the renter has the right to buy it at that predetermined level.
As an example, suppose your stock is trading at $25 when you sell your covered call and the strike price is $26. If the price stays below $26 for a predetermined time period you keep the stock, the premium and any dividends the security might generate.
If it rises above $26, the buyer has the right to purchase it at $26. Either way the seller gets the premium and the dividend.
It’s not easy to determine which stocks work best for covered call writing and the market sets the premium price, so it’s best to work with an advisor to determine if the reward is worth the risk.