Canadians over the age of 18 can take advantage of multiple investment and saving plans to secure their financial freedom. Two of the more popular saving plans include the Tax Free Savings Account (TSFA) and Registered Retirement Savings Plan (RRSP).
Both the TSFA and RRSP offer unique advantages that encourage individuals to start investing as early as possible. This includes investing in the stock market to take advantage of growth opportunities.
Yet unbeknownst to many, investors can gain similar exposure to stocks via options in their TFSA and RRSP accounts.
What is an option?
An option, as the name implies, gives an investor the option to buy and sell a stock at a predetermined price on or before a predetermined date. The main advantage is that options offer investors a cheaper alternative to benefit from the price fluctuation in a stock’s price.
There are two types of options an investor can buy: a call option and a put option.
A call option gives an investor the right (but not the obligation) to buy a stock at a pre-agreed price (known as a strike price) on or before a pre-agreed expiration date. If an investor expects the price of a stock to rise in value, they can purchase a call option that would in theory rise in unison with the underlying asset.
A put option grants an investor the right (but not the obligation) to sell a stock at a pre-agreed price (similarly known as a strike price) on or before a pre-agreed expiration date. A put option in theory moves in the opposite direction of the underlying asset. That is, if a stock loses value we would expect the value of the put option to rise in value.
Can you buy options in your TFSA or RRSP?
Buying options in your TFSA or RRSP is completely legal and a recognized investment strategy. Section 204 of the Canadian Income Tax Act confirms that options are one of several “qualified investments” available to all investors.
Some of the more common option strategies used in a TFSA and RRSP account include:
- Buying call options instead of a stock or ETF outright. In this scenario, an investor can gain exposure to favorable movements in a stock or ETF without committing a large amount of capital.
- Buying call options to guarantee an entry point. In this scenario, an investor locks in a purchase price for a stock or ETF regardless of the current market value.
- Buying put options instead of shorting a stock. Buying put options allows investors to profit when a stock or ETF loses value. If the underlying asset rises in price, the investor stands to lose 100% of the investment. By contrast, shorting a stock can result in the investor losing money above and beyond the initial investment.
- Covered call writing for advanced investors only. An investor who owns a stock or ETF outright can write a call option and generate new sources of income. The logic of covered call writing is to generate incremental revenue over the long-term.
Investors should consult with a tax expert because trading options in a TFSA account may trigger a tax bill. As the name implies, the TFSA is tax free in nature, but only when used as a long-term savings account. Investors that frequently buy and sell options in their account (akin to day trading) may be in violation of the spirit of the investment account.
However, investors using one or more option strategies in their TFSA as part of a long-term savings and investment strategy have nothing to worry about.
RRSP accounts are always subject to a tax when the investor withdraws their capital. The current tax schedule on RRSP withdrawals is 10% (5% in Quebec) on amounts up to $5,000, 20% (10% in Quebec) on amounts over $5,000, and 30% (15%) in Quebec on amounts over $15,000.
As is always the case, investors should consult with a tax and/or investment management professional for advice on how to minimize their tax obligations and maximize returns.
Originally Posted on February 1, 2022 – Options as part of an RRSP/TFSA strategy
Dollars expressed are in CAD
The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.
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Disclosure: Canadian Options Trading
Canadian Listed Options involve risk and are not suitable for all investors. Trading of certain standardized Canadian Listed Options may not be permitted for U.S. Residents. For more information read the Characteristics and Risks of Listed Canadian Standardized Options, also known as the options disclosure document (ODD). To receive a copy of the ODD call 877-745-4222 or copy and paste this link into your browser: https://www.cdcc.ca/f_en/Options_Disclosure.pdf
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Disclosure: Options Trading
Options involve risk and are not suitable for all investors. Multiple leg strategies, including spreads, will incur multiple commission charges. For more information read the “Characteristics and Risks of Standardized Options” also known as the options disclosure document (ODD) or visit ibkr.com/occ