Trading Canadian Options On The Montreal Exchange Can Result In Better Pricing For U.S. Investors

by: Big Babu

The Montreal Exchange is a Canadian Derivatives and Exchange that focuses on futures, equity, ETF and index options, as well as currency. As opposed to the US options exchange market where several different exchanges are available for trading (CBOE, AMEX, NSDQ, etc), the Canadian options are traded only on the Montreal Exchange.

Based in Montreal, Quebec, the Montreal Exchange trades in CAD. Therefore, all the quotes you see are denominated in Canadian dollars, and so are its margin requirements. Granted the Canadian Options market isn't as big or as liquid as the one in the US, it is still very comprehensive. At the time of writing, 291 equities are available for trading, including:

  • Royal Bank of Canada (NYSE:RY) - the largest bank in Canada by market cap
  • Suncor Energy(NYSE:SU) - one of the largest integrated energy company in Canada
  • Potash Corporation (NYSE:POT) - the largest potash producer in the world
  • TransCanada Corporation (NYSE:TRP) - energy generation and pipeline infrastructure
  • BCE Inc. (NYSE:BCE) - the largest telecommunications company in Canada

With a combined equity options volume of 2,370,642 (including both calls and puts) in the month of March 2012, the Montreal Exchange isn't exactly a "big" market. However, the options volume of the top 5 equities are still pretty respectable:

  • Manulife Financial (NYSE:MFC) - options volume of 261,764 or 11.04% of total volume on the exchange.
  • Bombardier Inc (OTCQX:BDRBF) - options volume of 161,003 or 6.79% of total volume on the exchange.
  • Bank of Nova‐Scotia (NYSE:BNS) - options volume of 89,027 or 3.76% of total volume on the exchange.
  • Toronto-Dominion Bank (NYSE:TD) - options volume of 83,259 or 3.51% of total volume on the exchange.
  • Royal Bank of Canada - options volume of 80,455 or 3.39% of total volume on the exchange.

To put things in perspective, we can compare the top 5 equities traded on the Montreal Exchange to the ones traded on all the US exchanges (AMEX, ARCA, BATS, BOX, C2, CBOE, ISE, NSDQ, PHLX) for the month of March 2012:

  • Manulife Financial - options volume of 12,113
  • Bombardier Inc - no options traded on US exchanges
  • Bank of Nova-Scotia - options volume of 7,553
  • Toronto-Dominion Bank - options volume of 81,697
  • Royal Bank of Canada - options volume of 19,429

As you can see, except for Toronto-Dominion Bank, the options volume on the US exchanges significantly lag the volume on the Montreal Exchange, or are simply not available since the stock is not even listed. A lack of volume generally translates to worse bid-ask spread, lack of strike prices, and lower open interest. For an options income investor, this is detrimental to his or her return.

For US investors, it is particularly important to determine if a foreign equity has tradeable options on its native exchange. For example, a US investor wishing to diversify his or her portfolio may wish to turn to Canada for a play on natural resources or to gain exposure to Canadian banks. Instead of buying the Canadian equity listed on the US stock exchange and then trade the options on the US exchange, the US investor can simply buy the Canadian equity listed on the Canadian stock exchange and trade the options directly on the Montreal Exchange. This will result in better options pricing, which translates to more income for the covered call or cash-secured put writers.

To see the better options pricing, let's use Manulife Financial as an example:

Option quotes for MFC on April 30, 2012
Contract Exchange Bid Ask Volume Open Interest
May 13.0 Call US 0.75 0.85 2 312
May 14.0 Call US 0.20 0.30 16 442
May 13.0 Call Canadian 0.65 0.69 0 2630
May 14.0 Call Canadian 0.14 0.17 290 19623
May 13.0 Put US 0.20 0.30 3 915
May 14.0 Put US 0.65 0.85 150 1041
May 13.0 Put Canadian 0.21 0.25 42 570
May 14.0 Put Canadian 0.67 0.78 0 372

MFC closed at $13.67 USD and $13.51 CAD on April 30 2012. From the table above, we can see that the options price on the Canadian exchange has a much tighter bid-ask spread (difference between bid and ask price) for both calls and puts. One must keep in mind that the options price and strike price is quoted in the currency of the exchange. This explains why the May 13.0 call fetches a higher price on the US exchange (0.67 USD "in-the-money") than the Canadian exchange (0.51 CAD "in-the-money").

A tighter bid-ask spread is crucial if the options income investor ever wants to close the position he or she sold short. In our example, it makes more sense to trade MFC on the Canadian exchange.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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