7.2 Options Fundamentals: Calls, Puts & Moneyness

Canadian Securities Course CSC

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1 Introduction & Exam Overview

About the CSC Exams

2 Chapter 1: The Canadian Investment Marketplace

1.1 The Canadian Securities Industry & the Investment Dealer's Role 1.2 Financial Intermediaries: Banks, Trusts, Credit Unions, Insurers & Pension Funds 1.3 Financial Market Trends 1.4 Investment Capital, Financial Instruments & Financial Markets 1.5 Canadian Exchanges, ATSs, Dark Pools & the Order Protection Rule 1.6 Canadian Securities Regulators, the CSA & CIRO 1.7 Investor Protection: OSFI, CIPF and CDIC 1.8 Ethics, Standards of Conduct & the Client Focused Reforms 1.9 Conflicts of Interest, Complaint Handling & Remediation

3 Chapter 2: The Economy

2.1 Economics Foundations & Measuring Economic Growth 2.2 The Business Cycle & Economic Indicators 2.3 Inflation & Interest Rates 2.4 The Labour Market & Unemployment 2.5 The Bank of Canada & the Inflation-Control Target 2.6 Implementing Monetary Policy: The Operating Band, Market Operations & Transmission 2.7 Fiscal Policy, Deficits & the Challenges of Government Policy 2.8 International Finance & Trade: The Balance of Payments and the Canadian Dollar

4 Chapter 3: Features and Types of Fixed-Income Securities

3.1 The Fixed-Income Marketplace, Bond Terminology & Security 3.2 Protective Covenants, Retirement Provisions & Extendible/Retractable Features 3.3 Government of Canada Securities: T-Bills, Marketable Bonds & RRBs 3.4 Provincial & Municipal Debt and Strip Bonds 3.5 Corporate Bonds, Credit Spreads & Bond Ratings 3.6 Money Market Instruments, Floating-Rate Notes & International Bonds 3.7 Other Fixed-Income Securities & Reading Bond Quotes

5 Chapter 4: Pricing and Trading of Fixed-Income Securities

4.1 Bond Pricing, Price–Yield Relationships & Accrued Interest 4.2 Yield Calculations & Return Measures 4.3 The Term Structure of Interest Rates & Yield Curve Theories 4.4 Fundamental Bond Pricing Properties: Volatility Rules, Duration & Convexity 4.5 Bond Market Trading & Bond Indexes

6 Chapter 5: Common and Preferred Shares

5.1 Common Shares: Ownership Rights, Voting & Restricted Shares 5.2 Dividends, DRIPs, Stock Splits & Consolidations 5.3 Preferred Shares: Features, Cumulative Dividends & Taxation 5.4 Preferred Share Variations: Convertible, Callable, Retractable, Floating & Rate-Reset 5.5 Fundamental Equity Metrics & Ratios 5.6 Stock Indexes & Averages

7 Chapter 6: Equity Transactions

6.1 Order Types, Execution & Market Mechanics 6.2 Margin Trading: Long Accounts & Borrowing 6.3 Short Selling & Short-Margin Requirements 6.4 Trading & Settlement Procedures: T+1, CDS & Confirmations

8 Chapter 7: Derivatives

7.1 Derivatives: Role, Underlying Assets & Users 7.2 Options Fundamentals: Calls, Puts & Moneyness 7.3 Option Strategies & Risk Management 7.4 Forward & Futures Contracts 7.5 Rights & Warrants

9 Chapter 8: Corporations and their Financial Statements

8.1 Corporate Structures & Corporate Governance 8.2 The Annual Report, Accounting Standards & the Auditor's Report 8.3 The Balance Sheet & Income Statement 8.4 The Cash Flow Statement & Earnings Quality 8.5 Public Company Disclosure, Investor Rights, Take-Over Bids & Insider Trading

10 Chapter 9: Financing and Listing Securities

9.1 Government & Corporate Financing: Underwriting and Syndicates 9.2 The Prospectus Process, Stabilization & Purchaser Rights 9.3 The Exempt Market & Private Placements 9.4 The Listing Process: TSX, TSXV & Capital Pool Companies 9.5 Continuous Disclosure, Material Changes & Insider Reporting

11 Chapter 10: Investment Analysis

10.1 Methods of Equity Analysis & Macroeconomic Analysis 10.2 Fundamental Industry Analysis 10.3 Company Analysis: Competitive Advantages, Governance & the Dividend Discount Model 10.4 Discounted Cash Flow & Relative Valuation Multiples 10.5 Financial Statement Ratio Analysis 10.6 Assessing Preferred Share Investment Quality 10.7 Technical Analysis: Charts, Trends & Patterns 10.8 Technical Indicators, Volume, Breadth & Sentiment

12 Chapter 11: Portfolio Analysis

11.1 Measuring Investment Return 11.2 Measuring Risk: Types of Risk, Standard Deviation & Downside Measures 11.3 Portfolio Risk & Return: Correlation and Diversification 11.4 Beta, the Capital Asset Pricing Model & the Security Market Line 11.5 Portfolio Manager Styles: Equity & Fixed Income 11.6 The Portfolio Management Process: Objectives, Constraints & the IPS 11.7 Asset Mix, Monitoring, Performance Evaluation & Rebalancing

13 Chapter 12: Alternative Investments, Other Managed, and Structured Products

12.1 Alternative Investments: Structures, Fees & Liquid Alternatives 12.2 Alternative Strategies, Performance Measurement & Due Diligence 12.3 Segregated Funds, Labour-Sponsored Funds & Listed Private Equity 12.4 Income Trusts, REITs & Closed-End Funds 12.5 Structured Products: PPNs & Market-Linked GICs 12.6 Split Shares & Asset-Backed Securities

14 Chapter 13: Mutual Funds

13.1 Managed Products & Mutual Fund Structure 13.2 Pricing Mutual Fund Units: NAVPS & Forward Pricing 13.3 Mutual Fund Fees, Sales Charges & Unit Series 13.4 Mutual Fund Regulation, Fund Facts & Account Opening 13.5 Types of Mutual Funds & Fund Management Styles 13.6 Redemptions, Withdrawal Plans & Measuring Fund Performance

15 Chapter 14: Exchange-Traded Funds (ETFs)

14.1 ETF Origins, Structure, Tax Efficiency & ETF Facts 14.2 ETF Creation, Redemption & Arbitrage 14.3 Types of ETFs & Advanced Strategies 14.4 Comparing ETFs, Mutual Funds & Individual Securities

16 Chapter 15: Working with the Institutional Client

15.1 The Institutional Marketplace & Institutional Clients 15.2 Institutional Investment Guidelines, Styles & Restrictions 15.3 Buy Side & Sell Side: Trading Desks, Revenue, Clearing & Best Execution 15.4 Block Trading, Dark Pools & Algorithmic Trading

17 Chapter 16: Fee-Based Accounts and Working with the Retail Client

16.1 Fee-Based Accounts: Managed & Non-Managed Models 16.2 Fee Transparency, CRM2 & Total Cost Reporting, and MWRR vs. TWRR 16.3 The Financial Planning Approach & the Life Cycle 16.4 Behavioral Finance, Sequence-of-Returns Risk & Client Coaching 16.5 Estate Planning Basics

18 Chapter 17: Canadian Taxation

17.1 The Canadian Taxation System 17.2 Taxation of Investment Income 17.3 Capital Gains, Losses & The Superficial Loss Rule 17.4 Registered vs Non-Registered Tax-Advantaged Accounts 17.5 Tax Planning Strategies, Pension Plans & the RDSP

7.2 Options Fundamentals: Calls, Puts & Moneyness

Key Takeaways Explain This Topic AI

An option is a legally binding derivative contract giving the buyer (holder) the right, but not the obligation, to buy (call) or sell (put) a specified underlying asset at a predetermined exercise (strike) price on or before expiration.

The option writer (seller) receives an upfront cash premium and assumes a binding contractual obligation: call writers must sell stock at the strike price if assigned, while put writers must purchase stock at the strike price.

Moneyness defines the intrinsic relationship between the underlying stock price and the strike price: calls are in-the-money when market price exceeds strike, whereas puts are in-the-money when market price is below strike.

Total option premium comprises intrinsic value (the immediate realizable value, bounded at zero) and time value (the premium reflecting time to maturity, expected volatility, interest rates, and dividends).

Break-even points establish the zero-profit threshold at expiration: long calls break even at Strike Price + Premium, while long puts break even at Strike Price - Premium.

Last updated: October 2026

Exchange-traded options are among the most versatile financial instruments available in capital markets. They allow investors to customize return distributions, hedge existing equity portfolios against adverse declines, generate supplemental cash flow, and achieve magnified speculative leverage with predefined capital exposure. In Canada, standardized exchange-traded options are listed on the Bourse de Montréal (MX) and cleared through the Canadian Derivatives Clearing Corporation (CDCC) .

1. Core Mechanics: Rights, Obligations, and Contract Terms

An option is a standardized derivative contract between two parties that grants the purchaser the right—without any obligation—to buy or sell a specified quantity of an underlying asset at a fixed price within a defined time frame. Foundational Contract Terms:

- Underlying Asset: The common stock, ETF, or index upon which the option is written (e.g., Royal Bank of Canada, iShares S&P/TSX 60 ETF).

- Contract Multiplier: In Canada, standard equity option contracts cover exactly 100 shares of the underlying stock.

- Strike (Exercise) Price: The guaranteed transaction price per share at which the underlying stock may be bought or sold.

- Expiration Date: The date upon which the option contract terminates and ceases to exist. Standard Canadian monthly equity options expire on the third Friday of the expiration month.

- Option Premium: The market price paid by the buyer to the seller per share (quoted on a per-share basis, so a \$2.50 premium represents a total cash outlay of \$250.00 for a 100-share contract).

The Two Contract Types: Calls and Puts

Every option contract belongs to one of two fundamental classifications:

Call Option: Grants the holder the right to buy the underlying shares at the strike price. Buyers are bullish; writers are bearish or neutral.

Put Option: Grants the holder the right to sell the underlying shares at the strike price. Buyers are bearish; writers are bullish or neutral.

Exercise Styles: American vs. European

American-Style Options: May be exercised by the holder on any business day up to and including the expiration date. Standard equity and ETF options traded on the Bourse de Montréal are American-style.

European-Style Options: May be exercised only on the final expiration date . Many index options (such as the S&P/TSX 60 Index Option, ticker SXO ) are European-style, which simplifies pricing and risk modeling for institutional writers.

2. The Four Fundamental Option Profiles

An investor can participate in the options market in one of four foundational roles. The rights, obligations, risk boundaries, and directional market expectations of each profile are summarized below: MARKET OUTLOOK

• BULLISH BEARISH
• +-------------------------+-------------------------+
• B | LONG CALL | LONG PUT |
• U | - Right to BUY | - Right to SELL |
• Y | - Max Gain: Unlimited | - Max Gain: Strike - P |
• E | - Max Loss: Premium | - Max Loss: Premium |
• R +-------------------------+-------------------------+
• S | SHORT PUT | SHORT CALL |
• E | - Obligation to BUY | - Obligation to SELL |
• L | - Max Gain: Premium | - Max Gain: Premium |
• L | - Max Loss: Strike - P | - Max Loss: Unlimited |
• +-------------------------+-------------------------+
• 1. Long Call (Call Buyer / Holder)

Action: Pays the cash premium upfront.

Right: Holds the right to purchase 100 shares at the strike price at any point prior to expiration.

Directional Bias: Bullish (profits when the stock price rises significantly).

Maximum Gain: Theoretically unlimited , as the stock price can climb indefinitely.

Maximum Loss: Strictly limited to the premium paid (occurs if the stock finishes at or below the strike price).

2. Short Call (Call Seller / Writer)

Action: Collects the cash premium upfront.

Obligation: Assumes the contractual obligation to sell 100 shares at the strike price if assigned an exercise notice.

Directional Bias: Bearish to Neutral (profits if the stock remains stagnant or declines).

Maximum Gain: Strictly limited to the premium received .

Maximum Loss: Theoretically unlimited if the position is uncovered (naked), because the writer must buy shares on the open market at ever-increasing prices to satisfy the exercise assignment.

3. Long Put (Put Buyer / Holder)

Action: Pays the cash premium upfront.

Right: Holds the right to sell 100 shares at the strike price on or before expiration.

Directional Bias: Bearish (profits when the stock price falls significantly).

Maximum Gain: Substantial, reaching a maximum of Strike Price − Premium Paid \text{Strike Price} - \text{Premium Paid} Strike Price − Premium Paid if the underlying stock drops to $0.00 .

Maximum Loss: Strictly limited to the premium paid (occurs if the stock finishes at or above the strike price).

4. Short Put (Put Seller / Writer)

Action: Collects the cash premium upfront.

Obligation: Assumes the contractual obligation to purchase 100 shares at the strike price if assigned.

Directional Bias: Bullish to Neutral (profits if the stock remains stable or rises).

Maximum Gain: Strictly limited to the premium received .

Maximum Loss: Substantial, reaching Strike Price − Premium Received \text{Strike Price} - \text{Premium Received} Strike Price − Premium Received if the stock plunges to $0.00 .

3. Option Moneyness: In-the-Money, At-the-Money, and Out-of-the-Money

Moneyness describes the economic relationship between the current market price of the underlying common share ( S S S ) and the option's strike price ( K K K ). Moneyness determines whether immediate exercise of the contract would generate positive intrinsic cash value.

Moneyness Classification Call Option Condition Put Option Condition Economic Definition

In-the-Money (ITM) Market Price > Strike Price ( S > K S > K S > K ) Market Price < Strike Price ( S < K S < K S < K ) Exercising the contract yields an immediate economic benefit relative to the prevailing open market price. The option has positive intrinsic value.

At-the-Money (ATM) Market Price = Strike Price ( S = K S = K S = K ) Market Price = Strike Price ( S = K S = K S = K ) The market price equals the strike price. The option contains zero intrinsic value; its premium consists entirely of time value.

Out-of-the-Money (OTM) Market Price < Strike Price ( S < K S < K S < K ) Market Price > Strike Price ( S > K S > K S > K ) Exercising the contract would produce an inferior transaction compared to open market execution. Intrinsic value is strictly zero.

Practical Moneyness Scenario Table

Consider a TSX-listed stock currently trading at $50.00 per share . The table below evaluates the moneyness status of calls and puts across different available strike prices:

• Strike Price ( K K K ) Call Moneyness Call Intrinsic Value Put Moneyness Put Intrinsic Value
• $40.00 ITM ( 50 > 40 50 > 40 50 > 40 ) $10.00 OTM ( 50 > 40 50 > 40 50 > 40 ) $0.00
• $45.00 ITM ( 50 > 45 50 > 45 50 > 45 ) $5.00 OTM ( 50 > 45 50 > 45 50 > 45 ) $0.00
• $50.00 ATM ( 50 = 50 50 = 50 50 = 50 ) $0.00 ATM ( 50 = 50 50 = 50 50 = 50 ) $0.00
• $55.00 OTM ( 50 < 55 50 < 55 50 < 55 ) $0.00 ITM ( 50 < 55 50 < 55 50 < 55 ) $5.00
• $60.00 OTM ( 50 < 60 50 < 60 50 < 60 ) $0.00 ITM ( 50 < 60 50 < 60 50 < 60 ) $10.00
• 4. Anatomy of Option Premium: Intrinsic Value vs. Time Value

The total market price of an option—the premium —is determined continuously by auction trading on the exchange. The premium reflects two distinct financial components:

Option Premium = Intrinsic Value + Time Value \text{Option Premium} = \text{Intrinsic Value} + \text{Time Value} Option Premium = Intrinsic Value + Time Value

Intrinsic Value Calculations

Intrinsic value represents the immediate cash payoff that would be realized if the option were exercised right now. Because an option holder will never voluntarily exercise an out-of-the-money contract, intrinsic value can never be negative :

Call Intrinsic Value = max ⁡ ( 0 , S − K ) \text{Call Intrinsic Value} = \max(0, S - K) Call Intrinsic Value = max ( 0 , S − K ) Put Intrinsic Value = max ⁡ ( 0 , K − S ) \text{Put Intrinsic Value} = \max(0, K - S) Put Intrinsic Value = max ( 0 , K − S )

If an option is at-the-money or out-of-the-money, its intrinsic value is $0.00 .

Time Value (Extrinsic Value)

Time value is the portion of the premium that exceeds the intrinsic value:

Time Value = Option Premium − Intrinsic Value \text{Time Value} = \text{Option Premium} - \text{Intrinsic Value} Time Value = Option Premium − Intrinsic Value

Time value reflects the market's willingness to pay for the probability that favorable price movement will occur prior to expiration. Five fundamental variables govern time value and overall option pricing:

Time Remaining to Expiration: Options are "wasting assets." As expiration approaches, the probability of favorable price swings diminishes, causing time value to erode—a phenomenon known as time decay (measured by the Greek letter Theta ). Time decay accelerates rapidly during the final 30 to 45 calendar days before expiry.

Volatility of the Underlying Asset: Volatility measures the magnitude of expected price fluctuations. Because an option holder possesses asymmetric upside with limited downside, higher expected price swings increase the probability of finishing deep in-the-money. Consequently, higher volatility increases the time value and total premium of both calls and puts (measured by Vega ).

Risk-Free Interest Rates: Higher interest rates increase the carrying cost of holding underlying stock, making call options (a leveraged stock substitute) more attractive and put options less attractive. Thus, rising interest rates increase call premiums and decrease put premiums ( Rho ).

Cash Dividends: When a stock trades ex-dividend, its share price drops by the dividend amount. Anticipated dividends reduce the forward share price, thereby lowering call premiums and increasing put premiums.

Distance to the Strike Price: At-the-money options possess the greatest dollar amount of time value, as the eventual outcome at expiration is the most uncertain.

5. Break-Even Calculations & Payoff Profiles

Understanding the exact financial outcome at expiration is critical for evaluating risk and reward. At expiration, all time value has completely decayed to zero (Time Value = $0), meaning the option's value equals its intrinsic value alone.

Long Call Payoff & Break-Even Analysis

A call buyer requires the underlying stock price to climb above the strike price by an amount equal to the premium paid to recoup their initial investment:

Call Break-Even Price = Strike Price + Premium Paid \text{Call Break-Even Price} = \text{Strike Price} + \text{Premium Paid} Call Break-Even Price = Strike Price + Premium Paid

Worked Numeric Walkthrough: Long Call

An investor buys 1 Enbridge (ENB) Oct 50 Call at a premium of $3.00 when ENB is trading at $50.00. The contract covers 100 shares, requiring a total cash outlay of $300.00 .

Break-Even Price = $ 50.00 + $ 3.00 = $ 53.00 \text{Break-Even Price} = \$50.00 + \$3.00 = \$53.00 Break-Even Price = $50.00 + $3.00 = $53.00

Stock Price at Expiry Gross Call Value (Payoff) Less Premium Paid Net Profit / (Loss) Per Share Total Position P/L (100 Shares)

• $40.00 $0.00 (Expires OTM) -$3.00 -$3.00 -$300.00 (Max Loss)
• $45.00 $0.00 (Expires OTM) -$3.00 -$3.00 -$300.00 (Max Loss)
• $50.00 $0.00 (Expires ATM) -$3.00 -$3.00 -$300.00 (Max Loss)
• $53.00 $3.00 (ITM) -$3.00 $0.00 $0.00 (Break-Even)
• $58.00 $8.00 (ITM) -$3.00 +$5.00 +$500.00

$65.00 $15.00 (ITM) -$3.00 +$12.00 +$1,200.00 Long Call Profit/Loss Profile:

• Profit ($)
• ^
• | / (Unlimited Upside)
• | /
• $0 -+--------------------/------------> Stock Price
• | / \
• $3.00 +=========+========+ \
• | | | Break-Even = $53.00
• +---------+--------+----------------->
• $0 Strike ($50)
• Long Put Payoff & Break-Even Analysis

A put buyer profits when the stock drops below the strike price. To break even, the stock must decline below the strike price by the cost of the premium:

Put Break-Even Price = Strike Price − Premium Paid \text{Put Break-Even Price} = \text{Strike Price} - \text{Premium Paid} Put Break-Even Price = Strike Price − Premium Paid

Worked Numeric Walkthrough: Long Put

An investor buys 1 Nutrien (NTR) Jan 70 Put at a premium of $4.50 when NTR trades at $70.00. The total cash investment is $450.00 .

Break-Even Price = $ 70.00 − $ 4.50 = $ 65.50 \text{Break-Even Price} = \$70.00 - \$4.50 = \$65.50 Break-Even Price = $70.00 − $4.50 = $65.50

Maximum Potential Gain = ( $ 70.00 − $ 4.50 ) × 100 = $ 6 , 550.00 ( if NTR drops to $ 0.00 ) \text{Maximum Potential Gain} = (\$70.00 - \$4.50) \times 100 = \$6,550.00 \quad (\text{if NTR drops to } \$0.00) Maximum Potential Gain = ( $70.00 − $4.50 ) × 100 = $6 , 550.00 ( if NTR drops to $0.00 )

Stock Price at Expiry Gross Put Value (Payoff) Less Premium Paid Net Profit / (Loss) Per Share Total Position P/L (100 Shares)

• $0.00 $70.00 (ITM) -$4.50 +$65.50 +$6,550.00 (Max Gain)
• $55.00 $15.00 (ITM) -$4.50 +$10.50 +$1,050.00
• $65.50 $4.50 (ITM) -$4.50 $0.00 $0.00 (Break-Even)
• $70.00 $0.00 (Expires ATM) -$4.50 -$4.50 -$450.00 (Max Loss)
• $75.00 $0.00 (Expires OTM) -$4.50 -$4.50 -$450.00 (Max Loss)

$85.00 $0.00 (Expires OTM) -$4.50 -$4.50 -$450.00 (Max Loss) Long Put Profit/Loss Profile:

• Profit ($)
• ^
• +$65.50 + \ (Max Gain at $0)
• | \
• | \
• $0 -+----+----------------------------> Stock Price
• | \
• $4.50 +======+==================+=======>
• | \ |
• | Break-Even Strike ($70)
• | ($65.50)
• +--------------------------------->
• Summary of Payoff Formulas for Standard Positions

• Strategy Break-Even Price Maximum Profit Maximum Loss
• Long Call Strike + Premium \text{Strike} + \text{Premium} Strike + Premium Unlimited Premium Paid

Short Call (Naked) Strike + Premium \text{Strike} + \text{Premium} Strike + Premium Premium Received Theoretically Unlimited

Long Put Strike − Premium \text{Strike} - \text{Premium} Strike − Premium Strike − Premium \text{Strike} - \text{Premium} Strike − Premium Premium Paid

Short Put (Naked) Strike − Premium \text{Strike} - \text{Premium} Strike − Premium Premium Received Strike − Premium \text{Strike} - \text{Premium} Strike − Premium