Although there is no shortage of trading tools for options on the Web, most are geared toward U.S. options. Few focus on Canadian options contracts. That said, there are a number of free tools available on the Montreal Exchange’s Web site (www.m-x.ca). The MX is home to Canadian derivatives trading.

One tool available on the MX’s Web site is the options calculator. Once you’re on the main page of the site, click on “Options calculator” under “Trading tools” on the left-hand side of the page. This tool allows you to calculate the theoretical fair value (TFV) of a particular options contract — or, conversely, the volatility being implied by the current option price. Either approach can assist a trader in understanding which strategy makes the most sense.

For example, suppose that you are bullish on a particular stock. Within the option pricing formula, all factors except volatility are known. Volatility, of course, must be estimated.

In the end, whether an option is overpriced or underpriced — meaning that its TFV is either less or greater, respectively, than the option’s actual price — comes down to whether you believe the market is overstating or understating the future volatility of the underlying stock. In either case, you must have some estimate to plug into the formula.

Suppose, for example, you believe that the best estimate of volatility is the underlying stock’s most recent 90-day historical volatility, which is the annualized 90-day standard deviation of returns for the underlying stock. If so, you would plug into the option calculator all of the known factors — stock price, strike price, time to expiration, risk-free rate and dividends payable — as well as the 90-day historical volatility number.

For the record, the option calculator requires an annual volatility input. The historical volatility calculation you just completed only took into account 90 days. Before inputting this data into the calculator, you have to first annualize the number. To annualize it, you simply multiply the 90-day volatility by the square root of the time you want to analyse. In this case, time is the square root of 365 days divided by 90 days.

Once you have inputted a volatility assumption, you then click on “calculate.” The option calculator will provide a TFV. The question, of course, is what does that mean to you?

Well, if the TFV is greater than the current price of the option, then the option’s current price is cheap — meaning that it’s trading for less than its fair value. Since you were looking to implement a bullish strategy, you would in this case, buy the undervalued calls.

If, on the other hand, you went through the same exercise and discovered that the option’s current price was greater than its TFV, you have, by definition, concluded that the options are overvalued — and you would be better off employing an option-writing strategy. Again, since you are bullish, you would look at covered call writing or naked put writing rather than a call buying strategy. Covered call writing and naked put writing are both bullish strategies that involve writing overvalued options rather than buying undervalued options.

The other trading tool on the MX’s Web site that I find particularly useful is the covered call writing calculator (www.m-x.ca/marc_options_info_calc_en.php). According to the MX: “The covered call calculator enables conservative inves-tors to find option series that can generate their desired levels of current and potential returns. The potential total return is the sum of two components: the option premium return and the potential capital gain.”

This calculator is an excellent tool for covered call writing, which is, by far, the most popular option strategy. With the covered call calculator, you can screen the Canadian universe of covered call writes to assess which strategy best meets your needs. And all of this is done on a rate-of-return basis.

Going back to the total return concept, the calculator allows you to set screens on the basis of premium income and capital gains. That allows you to prioritize which component of the covered call write is most important.

For example, suppose you were interested in a covered call write that provided a 15% premium and a 5% potential capital gain with an expiry in December. (Note: these returns assume current option prices for which the returns are annualized.) The example cited above yields 117 candidates, with the primary one being Ivanhoe Mines Ltd. Dec. 16 calls (symbol: IVN; price at time of writing: $12.84), which has a premium of 40¢.

@page_break@If you set the calculator to prioritize by premium, with 0% capital gain assumption, it will typically yield at-the-money covered call writes. If you prefer to increase the potential capital gain and reduce the premium component, the calculator will typically provide you with out-of-the-money covered call writes.

Obviously, the calculator screens only on the basis of rate of return. It does not purport to analyse the merits of the underlying stock, which is to say that it simply sets out to screen the second step in the process of putting together an options writing program. This means that you still need to have a view on the underlying security. And if you are writing calls, that view should be bullish.

The bottom line: for traders looking for some help in analysing Canadian options positions, these tools are excellent resources. Just as important, they are free. Just visit the MX Web site. IE