Kurt Pedersen, CA, B. Comm., Senior Vice President, Investment Advisor
Edward Rha, CA, CFA, B. Comm., Investment Advisor
Risk management
There are a variety of risk management strategies that we deploy in order to avoid excessive risk or preserve capital depending on the unique objectives of each of our clients. Such strategies include stop losses, exchanged traded funds and option strategies such as covered call writing, put writing and purchasing of puts as described below.
Covered call writing
This is a conservative option strategy designed to generate cashflow that is taxed at a lower rate than other income sources. On a security that is owned within the portfolio, we would sell a call option, which gives the buyer of the call the right to buy the shares from us at a specified price. For example, if the shares were trading at $80, we might sell a call option with a strike price of $85 in exchange for a premium of $5. The expiry of the call will vary, but assuming it expires in two months, if the shares are trading above $85, we would be forced to sell the shares at $85 regardless of the level they are trading at (called away). If the shares are trading below $85, we would keep the shares. In either case, you would receive the $5 call premium that is taxed as a capital gain.
Purchasing of puts
Quite simply, purchasing a put is like buying insurance on an individual stock or across an entire portfolio. A put option gives the holder the right to sell a security or an index at a specified price up until a designated date in the future (expiry). In exchange for this right, the purchaser pays a premium. The premium is the cost of a put or call which varies depending on a number of factors such as the time until expiry and the volatility of the underlying security. A put option can be used to protect against sudden downturns in the market.
Selling puts
In the event that an investor would like to buy shares in a certain company but believes the share price will drop and he or she will be able to purchase the shares at a lower price, they might consider writing a put which involves the receipt of a premium in exchange for assuming the commitment to buy the shares at a specified price.
The above are simplified explanations of option strategies. There are a variety of other considerations that may be relevant in each situation where an option strategy is being considered. We advise clients regularly on a variety of strategies.