I can't believe I have to explain this, but.

When you write options, the premium you receive is NOT equal to your investment returns.

It's only half the trade.

There are a ton of amateur traders on this platform who have stumbled upon some extremely well-known strategies and think they can magically pump out returns higher than the greatest investors in the history of humankind.

And they are very, very vocal about it.

I’m going to explain why you should ignore them with prejudice.

Options valuation is exceedingly complex, and there are dozens of strategies from iron condors to butterflies to fig leaves.

I'm not going to get into that.

I’m going to explain this using every amateur’s two most favourite strategies:

1. Cash-secured puts
2. Covered calls

First - what are options?

Options are contracts between two parties agreeing to transact at a predetermined price on or before a specific date.

They are derivatives, which just means their value is "derived" from some other underlying asset, like stocks or futures.

There is a buyer and a seller.

Buyers gain the right to buy or sell the underlying asset at the predetermined price before the contract expiry date.

Sellers on the other hand are obligated to buy or sell if the buyer exercises their rights.

With most options, buyers can exercise their rights any time before the expiry date.

Buyers pay money to sellers because the "option" to take a specific action against someone who is obligated to comply is worth something.

Selling options vs. buying them

When a seller writes or sells an option, the buyer pays them a premium right there and then.

And this is where amateurs get hung up - they think that premium is their investment return.

It's a component of it, but it's only half the trade.

Once they collect that premium, the seller has an open option position, much like shorting a stock.

And a lot can happen before they close it out.

Since they're selling something they didn't own, the only way to close their position before the expiry date is to buy the same contract at the current market price.

Which could be higher or lower than the premium they received.

It's the difference between the premium received and the cost to buy the contract back that determines the return on the trade - and it can be negative.

Alternatively, if the option buyer exercises their rights to buy the stock (with call options) or sell the stock (with put options), then instead of buying the contract to close their position, the seller will either have to sell the shares to the option buyer (call options) or buy the shares from the option buyer (put options) at the predetermined strike price.

Don’t worry, I’ll explain calls vs. puts more below, with examples.

Options pricing

The value of the contract over time depends on several variables, including the volatility of the underlying and the length of the contract.

Again, option pricing is incredibly complex. I’m just scratching the surface here.

The main variables that new option traders look at are:

1. The strike price

This is the price at which the buyer and seller have agreed to transact. If the strike price is $100 per share, then the parties have agreed that someone can/must buy the stock at $100 per share, and the other can/must sell it at $100 per share.

2. Days to expiration (DTE)

Each contract has an expiry date, ranging from today (0 DTE) to 2 years+. At the end of the day on this date, the contract either expires worthless or will be exercised by one of the parties.

3. Volatility/Implied volatility

Some stocks are more volatile than others. More volatile stocks have a higher probability of hitting a given strike price, so premiums for selling volatile stocks are higher than for lower volatility stocks.

Calls and Puts

Calls
Let's start with call options since they’re a bit easier to understand.

The buyer of a call option is buying the option, but not the obligation, to buy 100 shares of a stock at a defined price before a specific date.

As I write this, shares of APPL are trading for $227.
If I think APPL is going to rise in the short term, I can either buy the shares, or I can buy a call option, which gives me the right to buy 100 shares at a certain price.

Right now, I can buy a call option that expires on July 26th (two weeks from now), with a strike price of $230, for $3.50.

If I buy this option, I will pay the seller $3.50 per share, x 100 shares = $350. The seller will get this $350 premium for selling me the option.

If the price of APPL starts going up, my contract will be worth more than $350 as it gets closer to $230 per share. If it goes down, my call option will be worth less than $350.

Let’s say that on July 26th, the price of APPL has risen to $235 per share. My options are now “in the money”, which means the market price of APPL is higher than the agreed-upon strike price.

Since there’s no time left before the contract expires, the value of the contract will be close to $5, which reflects the amount of profit I would get if I exercise my call option, buy the shares of APPL at the strike price of $230 per share, and immediately sell them on the open market for $235.

Or I can just sell the option contract for $5 per share, which is much simpler.

What happened to the call seller?

They owe me 100 shares of APPL at $230 per share.

But the market price is $235.

So they need to buy 100 shares in the open market for $23,500 and sell them to me for $23,000.

They’ve lost $500, minus the $350 in premiums I paid them for a total loss of $150.

To simplify this, they can just buy the contract back for $500, which gives them the same $150 loss.

If they owned 100 shares of APPL in their portfolio, this would be known as a “covered” call.

Instead of buying the shares in the open market, they can just give me the shares they own for $230 each.

But since APPL is $235 in this case, they would have been better off not selling me the call option in the first place, and just owning the shares.

Puts
A put is slightly harder to grasp, but fundamentally similar.

The buyer gets the right to sell 100 shares at the strike price, and the option buyer is obligated to buy them.

If I think the price of APPL is going to fall before July 26th, I can either short the stock, or I can buy a put.

The $220 strike put is selling for $1.37 per share. If I buy it, I would pay the seller $137.

If by July 26th the price has dropped to $215 per share, the contract would be in the money and would be worth around $5.

That’s because I can exercise my put option, buy 100 shares of APPL at the current market price of $215 shares for $21,500, and sell them to the put seller for the strike price of $220 per share or $22,000.

My profit is $500 minus the option premium I paid of $137, for a total profit of $363.

What about the put seller?

They took in $137 when I bought the put.

But since the contract is now worth $5 per share x 100 shares = $500, they have to buy it back and take a loss of $363.

Instead, they can buy the 100 shares of APPL from me.

If they have the cash available to do this, it’s called a “cash-secured" put.

Sellers of cash-secured puts will often sell puts on stocks they wouldn’t mind owning. They claim their worst-case scenario is they get to own a stock they like at a price lower than today.

And while that’s true, it can still lead to some ugly losses.

In the example above, the put seller buys the shares for $220, but the market price is $215. What if the market price was $200 instead?

And what if it doesn’t recover?

They would be sitting on significant losses and would have been better off just waiting and using their cash to buy the stock at the lower market prices.

In the case of both calls and puts, if the seller isn’t covered by either owning the shares first (with calls) or having the cash available to buy my shares (cash-secured puts), it’s known as a “naked” trade.

Naked options carry significant risks of catastrophic loss for the seller.

Note in the examples above, I'm ignoring another important factor in options pricing known as "theta". Theta describes the "time decay" of an option's price.

As you get closer to the expiry date, the value of the contract drops because there's less time for it to hit the strike price.

I've ignored it to keep the examples simple.

The Wheel

Okay. Now that we understand a bit about options, we can review every amateur’s favourite strategy, “the wheel”.

1. Sell a cash-secured put.

2. If the stock never hits your strike, the contract expires worthless. In that case, the full premium you took in was a return on the cash you are holding to secure the put contract. If that happens, you sell another cash-secured put.

3. If the option goes in the money, and the put buyer exercises, you buy the 100 shares of APPL.

4. Then, you sell covered calls on your shares, collecting more premiums, until your call option goes in the money. You sell the APPL shares and then repeat the whole process.

On paper, this seems too good to be true.

You “wheel” in and out of holding cash, collecting premiums, owning the stock, and collecting more premiums.

Free money right?

Not even close.

Stocks are volatile.

Prices can move violently in either direction, and often do.

Most of the lifetime returns of any given stock happen on only a handful of trading days.

And the majority of stocks perform quite poorly in the long run.

Let’s say in the example above, you sell the $220 put and APPL drops to $190 per share. You bought it for $220 per share, and are selling calls against it trying to recoup your losses.

If you sell a call at the $220 strike price, the premium you receive will be a pittance. The strike price is so far away from the current price, and so unlikely to hit the strike in the short term, that no one is going to pay you much for the call option.

To get a premium that is worth the commission of selling it, you’ll need to pick a strike price much closer to the current market price, say $200.

What happens if APPL moves violently upward through your strike price?

You have to sell it for $200.

But you bought it for $220.

You’ve lost $20 per share, or $2,000, minus the premiums you took in.

And in the short term, you won’t have taken in nearly enough premiums to cover the $2,000 loss.

But let me get back to my opening statement.

I recently got into an argument with one of these amateur traders who claimed that it was “easy” to generate weekly investment returns of 1%.

Weekly.

That works out to a compound annual return of 68%.

If you could compound your money at 68% annually, starting with $100,000, not only would you be the greatest investor in the history of mankind, but after only 29 short years you’d have more money than the richest person on the planet today.

In 43 years you would own all of the wealth in the world.

Over $420 TRILLION.

Before commissions and taxes, of course.

There’s a reason these strategies are known as picking up pennies in front of a steamroller.

Vocal, amateur proponents have likely never seen a significant bear market or had a trade move violently against them.

They haven't seen the steamroller.

Yet.

I think the best analogy is Nassim Taleb’s famous turkey:

When selling options, it works until it doesn’t.

And when it doesn’t, you can get your head lopped off.

Finally, given that the majority of options volume is institutional investors, these amateurs should ask themselves:

Who's taking the other side of this trade?

If I can “easily” make 1% per week like some of these people claim, who's willing to lose 1% per week being on the opposite end of this incredibly well-known and obvious investing strategy?

And why aren’t these professionals, with their vast access to talent, resources, and technology, simply printing money with these strategies?

Because there is no free lunch.

And in a market as competitive as stock options, you’re probably the turkey. @GrindeOptions this one's for you

Do you own segregated funds?

Has someone pitched them to you touting the vast benefits, including principal guarantees and efficient estate planning?

Gather round, we're going deep on this one.

👇 Seg funds go by a few names, including Guaranteed Investment Funds (GIFs) and Variable Annuities.

They've been around in Canada for over 60 years, and have ballooned to over $130 billion in AUM.

They can only be sold by someone with a life insurance license.

If I was just getting started learning about personal finance, or if I wanted to go the DIY route, here are the resources I would devour first.

And in this order. 1. @BoomerandEcho's blog

Robb Engen is a personal finance writer turned financial planner.

His blog is one of the best places to start as a beginner.

boomerandecho.com

I sold my rentals last year.

I was expecting a big tax bill due to the capital gains.

But I ended up with a $4,500 refund.

How?

Partially because of the +1 in the calculation of the principal residence exemption (PRE):

👇 We bought a pre-sale townhouse in 2016.

It wasn't complete until 2019.

In February 2019, we moved into it.

We moved into a new home in April 2020, barely a year later,

We turned it into a rental from May 2020 until we sold it in July of 2023.

Incorporated professionals got hit hard in yesterday's budget.

The biggest impact for many will be the increase in the capital gains inclusion rate for every dollar of capital gains in their corporation.

Let's look at the math to see how bad it is. Say you're a physician in BC and you use your corporate investment portfolio to fund your retirement.

As part of your annual income, you need to sell part of your portfolio, and you trigger a $50k capital gain.

It looks like this:

My wife and I each have $2M of term life insurance.

Why $2M?

Because that's how much it would take for us to ensure the survivor is financially independent for life.

Want to know how much life insurance you you need?

Well, let me tell you. For this calculation, you need to assume you die tomorrow.

While that's not likely, you're trying to figure out the financial risk that exists today.

And then you're going to pay an insurance company to take that risk for you.

My kids' RESP just crossed $70k.

I have 2 kids, aged 6 and 1.

I expect that by the time my oldest goes to school, the account will be well over $200k. How?

I superfunded it.

The lifetime RESP limit is $50k per child.

But the grants, which are paid at 20% on the first $2,500 contributed per year, are capped at $7,200.

There’s a hidden danger, lurking in the shadows, waiting to ambush your retirement plan.

What is it?

It’s called “sequence of returns risk”, or SORR for short.

Here’s how it works, and how to catch it before it pounces. 2 people:

- retire at the same age, a few years apart
- with the same portfolio value and withdrawal rate
- earn the same compound annual return in retirement

1 runs out of money, the other dies with more than they started with.

Huh?

How?

SORR, of course.

If you're incorporated, you should understand these terms:

1. CDA
2. NERDTOH
3. ERDTOH
4. GRIP

These are notional accounts - they exist on paper, not at your bank.

Here's what they mean:

👇 1. CDA

Capital Dividend Account.

The amount of tax-free dividends you can pay yourself from your corporation.

Most commonly, this comes from the tax-free half of capital gains generated through your corporate investment portfolio.

Life insurance payouts can add to this too.

Thinking of incorporating your business or practice?

There can be advantages.

But it also makes things a bit more complicated.

Here are 10 concepts to be familiar with:

👇 1. Salary vs. Dividends

First, salary.

- deductible to your corporation and fully taxable to you
- CPP contributions are mandatory
- generates RRSP room equal to 18% of your previous year's salary
- gives you the option to start an Individual Pension Plan (IPP) later

If you lower your tax bill too much, CRA says, 'lol, nice try,' and uses a separate calculation to determine your taxes owing.

It's called the Alternative Minimum Tax (AMT) and can be a nasty surprise.

Let's talk about:

- what it is
- when it applies
- planning strategies

👇 1. What is it?

AMT was introduced in 1986.

It prevents high-income earners from paying too little tax due to tax incentives like deductions and tax credits.

It can apply to individuals and trusts but doesn't apply to corporations.

And the Liberals intend to expand it.

Make sure you know what you're retiring to.

This was a hard post to write.

I almost didn't write it in fact. I've started and trashed this story many times.

But I believe there are important lessons in this story we can learn from.

Warning: this does not have a happy ending. This is a story about my dad.

My dad grew up the youngest of four siblings in Quebec.

He, his siblings, and my grandparents moved to Vancouver in the 70s, and my uncle opened a tile store.

My dad worked for him for a while, then eventually opened his own store.

You can over-contribute to your RRSP by up to $2,000 without penalty.

You can't deduct it from your income until the following year though.

Above this, you pay a 1% monthly penalty until it's withdrawn unless you withdraw it before the end of the month in which you contributed. First, you need to file a T1OVP form to report the over-contribution.

Then, when withdrawing the excess, you need to file another form to waive the withholding tax on the RRSP withdrawal.

That's form T3012A.

Great question from a follower yesterday:

They have $30k in net capital losses from last year.

They have $30k in TFSA room.

And they also have about $30k left in their non-registered portfolio.

Should they max out their TFSA?

Or stay invested in the non-registered account? They didn't want to lose the capital losses, so they considered using the non-registered account.

But it would have to grow from $30k to $90k to offset the capital losses fully.

That's because half your capital gains are taxable.

($90k-$30k)/2 = $30k taxable gains.

Move over RRSP Home Buyers' Plan (HBP) - there's a new kid in town.

The Tax-Free First Home Savings Account (FHSA) arrives on April 1st, 2023.

What is it?
How does it work?
What are the benefits?
What strategies can you use to make the most of it?

I'm glad you asked.

👇 Before we get into it, h/t to @AaronHectorCFP.

He's graciously shared his research, work and knowledge on the topic to everyone's benefit.

Much of this post comes from his work.

When Aaron talks, I listen - and so should you.

Follow him if you aren't already.

Did you know you can create your own defined benefit pension?

If you’re an incorporated business owner or professional – like a physician - you can create an Individual Pension Plan (IPP).

👇 Sometimes called a ''Super-Sized RRSP'', it offers many benefits:

1) Higher contributions than RRSPs

2) Tax-deferral and income splitting

3) Corporate tax deductions

4) Creditor protection

5) Guaranteed retirement income

6) Succession planning

Buckle up. We're going deep.

I've been getting a ton of DMs from non-physicians asking if they can work with me.

First of all, thank you - I'm honored.

Secondly - yes, I do work with non-physicians.

But I do my best work for incorporated business owners and professionals.

My framework: 1. Transparency

We begin with financial planning.

You need to be willing to share your goals, values, experiences, and attitudes regarding money.

It also means an in-depth look at all areas of your finances.

I'm an open book, and I promise full transparency in return.

RRSP returns are tax-free, just like a TFSA.

You heard me.

I said tax-free, not tax-deferred.

And for most, the returns are even better than tax-free.

Don't believe me?

Allow me to explain.

👇 To understand this you must realize your RRSP contribution is made with pre-tax dollars.

You don't think so, because your paycheque has taxes withheld.

So you usually compare an after-tax contribution to an RRSP vs. an after-tax contribution to a TFSA.

But that's wrong.

The 4 D's of tax planning:

- Deduct
- Defer
- Divide
- Decrease

These are the big ideas behind reducing your tax bill.

Let's look at each one and how they keep money in your pocket:

👇 1. Deduct

A deduction reduces the amount of income on which you pay taxes.

RRSPs are a common example.

If you make $100k, you pay tax on $100k.

But if you put $20k in an RRSP, you get a $20k deduction.

You only pay tax on $80k.

Thinking of selling a property to your kids for cheap?

Don't.

it will be double-taxed.

Say you bought a property for $500k.

It's worth $700k today, but you're thinking of selling it to your kids for $300k as a favour.

What happens? When dealing with non-arm's length parties, like family members, CRA deems the property to be sold at fair market value - regardless of the actual transaction price.

So your kid pays you $300,000, but CRA says "nice try" and pretends you sold it at $700,000.

If you left an employer pension, you may have transferred it to a Locked-In Retirement Account (LIRA).

Eventually, your LIRA will likely become a Life Income Fund (LIF).

It's like a RRIF, but it has a maximum withdrawal limit each year.

Here's a trick you probably didn't know: You can transfer the difference between the maximum LIF payment and the minimum LIF payment directly to an RRSP or RRIF on a tax-deferred basis.

Your maximum each year is the greater of the prescribed maximum set by CRA and your investment returns from the previous year.