Investoid

As the markets have see-sawed in the first quarter this year, I have been thinking about writing call options on my RRSP investments (this is known as a covered call strategy). Basically you are betting that your investments are not going to go up greatly in value in the near term - thus you give someone the option of purchasing your stocks at a price near the current one (depending on what you want to do, this could be below, at, or above the current price). If the markets go down or otherwise stay below your strike price, you get the pocket the option premium while keeping the underlying stock. Is this a feasible strategy for investors with their RRSP savings?

First, you need to determine whether you can write covered calls. Most RRSP accounts allow for covered call writing (as well as purchasing of calls and puts), so this isn’t usually an issue, but one you still need to verify. I was looking to write covered calls for my XFN and XIC holdings, and perhaps for XIN as well, so I needed to find out where the options are traded. All Canadian equities options are routed through the Montreal Exchange.

The first hurdle - if the MX doesn’t have options on the shares you wish to write covered calls, you’re out of luck. Turns out they don’t trade options for XIN or XIC (but they do for XIU), so already two out of three of my investments were nixed. For regular stocks, they have a good listing of the major large cap companies and popular sectors in Canada, but I find they are heavily focused on energy, materials, and financials (the complete listing is found here).

The next hurdle is trading fees - is it worth your while? 1 options contract is for 100 shares, so you need to multiply the bid/ask prices you see by 100 to get the total price you will receive for a call option. If I wanted to write a call option for XFN with an expiry of May at a price of 57, I could get $50 per contract at the last bid price. That’s not so bad on a percentage basis (about a 0.8% return on the share value + another 1.7% upside if they are sold at the strike price), except when you take commissions into account. Here is a sample of commission prices from Canadian brokerages:

• CIBC Investor’s Edge: $28 + up to $2.80 per contract
• TD Waterhouse: $29 + $1.75 per contract
• BMO Investorline: $35 + up to $3.50 per contract
• E-Trade (not active trader): $19.99 + $1.75 per contract
• TradeFreedom: $9.95 + $1.25 per contract + exchange fees

Note that this does not take into account the transaction fees you will incur if you option is exercised. As you can see, these fees make it relatively cost-prohibitive if you are trying to write a small number of contracts (which is likely if your portfolio is just getting started or if the holdings you wish to write options are are small). With a bank brokerage, any premium under $150-200 is almost completely eaten up by fees.

The last hurdle (and for me this was the biggest issue) - the liquidity and spread. The XFN volume on call options today was a big 0. That’s right, nothing, for any strike price or call date. While there are bid and ask prices for each option, the spread ranged between 10 and 30 cents. This can be over 20% of the option price. This makes the valuation of the options very volatile. You would really need to be satisfied with the price you are receiving for your calls and expect to give up your shares if the stock rises, rather than purchasing a cancelling call option on the open market later on.

Overall, I’ve decided against using a covered call strategy for now, based on my specific holdings. However, for people with more volatile holdings (such as XEG, individual oil or uranium companies and the like) who want to hold these assets long term but are not sold on their short term prospects, then covered call writing could be a good way to generate short term returns while waiting for the long term upside. With the right stock, covered calls can be like creating a monthly dividend on your equity.