Edward Kholodenko, President and CEO of Questrade, talks about why multi-leg option strategies are attracting so much attention, in conversation with financial writer Lori Bamber, author of the 50 Best Stocks for Canadians
LB: What should investors know about the new opportunities provided by multi-leg options?
There are multi-leg strategies for every type of investor.
For novice traders, multi-leg options make it possible to generate income from current holdings. For example, if you intend to hold a stock over the long term, but also want to generate income, you have the opportunity to sell a covered call.
There are opportunities for leverage, increasing the potential rewards of trading activity, which is especially attractive to those with limited capital to invest.
Multi-leg option strategies also provide more sophisticated traders, who are concerned about market volatility, with an opportunity to hedge their positions.
LB: Would you walk me through one strategy that an investor looking to leverage returns might apply?
Sure. Let's say you bought 100 shares of XYZ stock at $10. Your investment, excluding any commission costs, is $1,000. If the stock price rises to $11, the value of your shares becomes $1,100 and your return on investment is $100, or 10%.
Let’s take that same position and, using multi-leg options, sell a covered call, giving someone else the right to buy your shares at $12 until the options expire.
The value of your shares is still $1,100, but by selling the calls you may have collected an additional $50. If that call expires worthless, you have essentially increased the return on your investment from 10% to 15% simply by executing a multi-leg option strategy.
LB: What about a straightforward hedging strategy?
Absolutely. This time, we’ve bought 100 shares of XYZ at $10 and we’re unsure about the general market direction. We buy a put option, which will allow us to sell our shares at the strike price of $9. The premium is $.60, so with 100 shares, it will cost us $60.
If XYZ falls to $8, rather than losing 20% of our initial entry price, we’ll sell our shares at $9. We’re still losing a dollar per share, and paying a premium of $.60, but on the whole, we’re $.40 ahead of where we otherwise would have been. We've effectively managed to limit our downside risk – if the share price were to fall farther, to $5, for example, our maximum risk is still $1.60 per share.
LB: What if I’m more interested in commodities – is there a multi-leg option strategy that would enable me to speculate on the price of gold, for example?
Yes. Let's say you believe gold is about to have a huge moment. You don't know if it’s going to go up or down, but you think it’s going to really rock in one direction or another.
A long straddle allows you to buy one call and one put at the current market price of a suitable gold ETF. You’ll pick strike prices at or as close as possible to the current market price. If the price of gold moves strongly one way or the other, as you suspect, either the put or the call contract will gain more value. If it gains enough value to offset your initial entry price into this multi-leg strategy, you will profit – without a lot of risk exposure.
Learn more about trading multi-leg option strategies with Questrade.
: Questrade is a Stockhouse client.