After demonstrating how to take a confident stance on Toronto Dominion Bank using a protective put in last weeks blog titled Repositioning Using Puts , we see that a number of Canadian banks are starting the week off strong, occupying 6 of the 10 spots on today’s Most Active Options list:
If an investor had a specific expectation or preference to any one the banks highlighted above, the solution would be to take a position by purchasing the shares, using an option strategy or a combination of the two. However, if the outlook was not specific to a particular bank, but more based on a bullish outlook for the entire Canadian banking sector an exchange Traded Fund (ETF) could be selected to meet the investors objectives.
As a reminder, an ETF is a financial security that can be bought and sold on an exchange like common publicly traded shares. The difference is the share or unit value reflects the net asset value of a portfolio of stocks much like a typical mutual fund. The main difference is that the ETF offers the investor the ability to buy and sell at their discretion throughout the day while benefiting from the diversification of holdings. One other major consideration is that many ETF’s are options eligible. For a full list of all of the currently available options eligible Canadian ETF’s CLICK HERE.
The BMO S&P/TSX Equal Weight Banks Index ETF - symbol (TMX:ZEB) is an ETF comprised of Canadian banks. As of December 6th, 2013 the top holdings were as follows:
For more information on this ETF, please visit the BMO S&P/TSX Equal Banks Index ETF spec sheet.
As you will notice, all of the banks on today’s most active list are included in the composition of the ZEB. For the investor who would like exposure to this sector, but does not want to pick and choose between stocks, this is an ideal solution. The benefit is that any significant negative price action due to the unique circumstances of an individual bank is mitigated because it is averaged into the basket of stocks. The obvious draw back is that if one particular banking stock is outperforming, this is also mitigated by the average. Regardless, if “the tide comes in, and all ships rise” in the banking sector, the investor should participate in an appreciation of ZEB shares
There are a number of ways to participate in the longer term appreciation of ZEB shares.
- Buy the shares outright (unlimited profit, unidentified risk)
- Buy the shares and add a protective put (unlimited profit, identifiable risk but increased break even)
- Covered Call (limited profit, unidentifiable risk, benefit of cash flow)
- Buy the shares and collar them (limited profit, identifiable risk)
- Long term option (limited risk, unlimited profit)
- Longer term call Debit Spread (reduced cost, limited risk, limited profit)
- Longer term Calender Spread (ongoing reduction in cost, limited risk, limited profit but the ability to adjust as shares appreciate)
- Purchase a June 2014, 20 strike call
- Current asking price $1.45
- Delta = .75 (option will appreciate $0.75 for ever $1.00 the stock increases currently)
- Intrinsic Value = $1.00 ( Stock price - strike)
- Time Value = $0.45 (premium - intrinsic)
- Break even = $21.45 (strike plus premium)
Let’s assume for a moment that the North American economies are performing better than expected. Not a real leap considering that most analysts think the broader North American economy is walking on air, with looming US debt ceiling and sequestration debates and their fast approaching January 15th deadlines notwithstanding.
In fact, the real surprise could be some grand plan agreed to by the three branches of the US government which could eliminate the need for additional quantitative easing, and in a perfect world, return us to a point where good news is actually seen as good news.
In that light, Canadian exporters would do quite well. Given that Canada is leveraged to the US recovery, and for the last two years Canadian stocks have lagged their US cousins, it may be time for us to play catch up!
Assuming there is always a bull market somewhere – where have I heard that – traders’ might want to look at some Canadian companies that would benefit from a pickup in exports. Think about transportation companies like Canadian National Railways (TMX: CNR, Friday’s close $60.21) or Canadian Pacific (TMX: CP, $164.26) as starting points.
Covered calls might be the better approach for more conservative traders, say buying CNR and selling the March 62.50 calls at $1.15. The three month return if exercised is 5.8% if unchanged 1.9% and downside breakeven at $59.06. Another approach for more aggressive traders is to simply buy the June 62.50 calls at $2.00. Maximum potential is unlimited, maximum risk is the cost of the call.
With CP, consider buying the shares and writing the March 170 calls at $5.50. The four month return if exercised is 7.1%, if unchanged 3.5%, and downside breakeven at $159.76.
Another transportation company that I rarely mention is Air Canada (TMX: AC.B, $7.93) which,because of its low price, might appeal to some as an option substitute. There are no options on the company, probably because the stock itself acts a lot like an option. Not a buy and hold trade by any stretch but maybe as a short term trade over say the next three months!
Keeping with the airlines, Westjet (TMX: WJA, $28.06) may actually be a better choice. This company has options which open the door to a cash secured put position. Say writing the WJA April 28 puts at $1.65. This trade obligates you to buy the shares at $28 per share until the April expiration. If the stock is above that price in April the options will expire worthless. If you have to buy the shares your net cost will be $26.35 (i.e. $28 strike price less $1.65 option premium = $26.35).
One of the challenges with the current market is that stocks have been extending gains on a month over month basis with very few pull backs. This is great if you had the foresight to position yourself early. However, the probability of a correction increases everyday that the market pushes higher, diminishing the near-term upside potential. This makes jumping into the markets a less than attractive proposition from a risk/reward perspective. Many investors are now feeling the pain and humiliation from sitting on the sidelines. The question at hand is…do I get in now and weather a much needed correction (for the record, I am not suggesting a crash) or do I continue to stand on the sidelines and miss a continuation. Truly a “damned if you do, damned if you don’t” scenario.
This emotional conflict is well personified in Benjamin Graham’s allegory on Mr. Market, where he suggests “Sell him shares at a nice profit, and he happily takes their prices so much higher you are embarrassed to even mention them again. Buy something from him on the cheap, and he will show you exactly what cheap is”. Truly a dilemma.
How do you take a decisive stance on a stock that is overbought and benefit from a continuation higher in share price while hedging for a potential correction? The answer is a simple protective put.
Often times, investors familiar with the options market will look at a protective put as a way out of a stock in case a good investment goes bad. While that is one way that a put can be used, we also have to recognize that stocks don’t trade higher in a straight line. If the expectation is that a stock will trend higher over a longer time horizon, the put can be used to reposition at a lower price. This will reduce the average cost of the shares as well as the breakeven point.
Let’s consider an investor that has missed the move in Canadian banks. While the sector is strong, it is not immune to the natural ebb and flow of the markets. Recently, Toronto Dominion Bank (TSX:TD) has topped $98.00/share and has pulled back to just shy of $97.00. Now, this should not necessarily cause panic in current share holders, but it may cause aspiring investors to re-consider buying at these levels. After all, large corrections always start off small.
An investor may wish to purchase 100 shares of Toronto Dominion Bank(TSX:TD) at the current price of $96.85. This would require a capital outlay of $9,685.00. To hedge against a possible near term correction a January put at the 96 strike may be purchased for $1.75/share, or $175.00.
This immediately brings the average cost basis of the position to $98.60 as the cost of the put option is added to the average cost of the shares. However, the investor now has a maximum risk of $2.60/share from now until the expiration date of the option. The risk is calculated by adding the cost of the put to the difference between the share purchase price and the strike price.
Let’s assume that the shares drop down to $92.00 over the next month.
If the shares were trading down at $92.00 on expiration, the investor could exercise their right to sell the shares at $96.00. This would be bring in $9,600.00. The investor could then repurchase 104 shares at $92.00. Admittedly, the additional 4 shares doesn’t lower the average cost by much, but it will certainly help the recovery process. While the investor would not be able to purchase a protective put to hedge those 4 shares without being “over hedged” due to the 100 share multiplier, the additional dividend payments picked up will add to the bottom line.
If we consider the new average price of $92.00, the cost of the previous put and additional risk on the shares must still be accounted for. By adding $2.60 to $92.00 we arrive at the adjusted break even price of $94.60. As a result, the investor has continued to own Toronto Dominion Bank through a pull back, adjusting the break even on the shares to a lower and more easily attained level. The put protected investor would start to profit a little lower than $94.60 due to the additional 4 shares, needing only a $2.60 move. The unprotected investor that simply bought the shares and decided to wait it out would would need a $4.86 move just to break even.
- Posted by Patrick Ceresna on December 2, 2013 filed in MX Indices, Options Market, Trading Strategies
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Over the years, no topic has been more controversial then the use of options by investment advisors for unsophisticated clients. This has now reached levels where a number of Canadian wealth management firms have placed compliance restrictions on advisors, limiting them to using only the simplest strategies for their clients. Understandably, there have been advisors that have misused options and potentially exposed their firms to unnecessary liabilities; however, this mistakenly overshadows many unique benefits the options can offer the client.
Advisors today focus more and more on attracting high net worth clients. The problem is that it is becoming increasingly competitive to attract and close those clients. Many advisors seek to demonstrate strategies that create alpha (more attractive risk adjusted returns). The difficulty of today’s financial world is that the asset classes of cash and bonds have little to no yield, with a real risk of decline during any period of rising interest rates. This has many managers seeking creative solutions of enhancing returns without compromising the benefits of diversification.
Options to Manage Systemic Risk
Let’s debate the idea of allocating a percentage of a client’s assets to an index ETF with an options collar associated with it.
Let’s assume that the advisor is managing a client with $4,000,000 in assets. The advisor decides to allocate 10% of the clients assets to the iShares S&P/TSX 60 Index Fund (TSX:XIU). The advisor buys 20,000 shares at $19.41 and proceeds to collar the stock with a March 2015 $21.00 call and a March 2015 $18.00 put.
Shares 20,000 x $19.41
March 2015 $21.00 covered call ($0.40)
March 2015 $18.00 protective put ($0.90)
- $ 18,000.00
5 x Quarterly dividends (5 x 0.145*) *appox.
The covered calls will always yield less than the cost of the put as options discount the expected dividend payments. In general we can identify that the costs of the protection will be offset by the cash flow from the covered calls and dividends.
So what was the outcome? The first and most important objective is that the advisor has completely removed the risk of catastrophic drawdown if an unexpected market crash was to occur. Over the next 15 months the advisor has limited the downside risk to $18.00 or 7.26% lower from the entry price. But the loss would likely be less as sharp market declines are accompanied by material spikes in volatility which would grow the value of the protective put at a faster rate than the delta would suggest.
At the same time, the advisor has allowed the client the upside potential of $1.59 or 8.19%. If the bull market continues, the funds allocated to this strategy would be able to contribute to the expected returns for the client.
There is third and arguably more important advantage. The position has a substantially reduced volatility in seeking that 8% equity style return. The way to demonstrate this is by analyzing the net delta of the stock and collar combo.
March 2015 $21.00 covered call ($0.40)
March 2015 $18.00 protective put ($0.90)
What does this mean?
Let’s say an advisor had 20,000 shares of XIU for the client and the XIU dropped $1.00 from $19.41 to $18.41. From a volatility perspective, the client would have seen a $20,000.00 swing in their account balance. At the same time, the client that had the XIU shares open with the $18/$21 collar would have only experienced a $7,482.00 change (20,000 x 0.3741).
What has the advisor accomplished? Reduced volatility with no risk of a catastrophic loss. At the same time as providing the client with the ability to achieve stock market style returns. This certainly is something worth considering.
Despite sounding somewhat complex, a synthetic option strategy simply refers to combining an option contract with the underlying security to arrive at the same risk/reward profile of a specific options only position.
It is not always the intention of the investor to implement a synthetic position. More often then not, the synthetic is a direct result of some sort of an adjustment to an already existing position.
Reasons may include:
- Risk management
- Cash flow
- Change in directional bias
When considering the use of a synthetic over its options only counterpart, the investor must consider the additional cost associated, including the underlying shares of the security.
Before we do a comparative analysis with a real market example, below is a chart of some common option strategies and their synthetic alternative.
Let’s assume an investor is bullish on Agrium (TSX:AGU) and believes the shares will advance higher over the next year. If the objective is to benefit from an appreciation in share value with a limited risk exposure there are two ways this can be accomplished using options.
With the shares trading close to $94.00, the investor could purchase 500 shares for a total capital allocation of $47,000.00. If the objective is to limit the risk for the next year, 5 January 2015 protective puts at the 94 strike could be purchased for approximately $11.75. This would be a total of $5875.00(this does not include commissions).
The maximum risk exposure to the investor has been reduced to the cost of the puts until expiration. This is approximately 12.5%. This is assuming that the stock is purchased at $94.00 and a 94 strike put is being used as protection. In order to break even, the shares must be trading above the stocks purchase price plus the cost of the put. In this example, the investor would be sitting at a net loss if the stock is below $105.75 on expiration. This is because the put will have expired worthless and the stock has not risen high enough to compensate for its cost.
In comparison, a like minded investor could use a call option as a stock replacement strategy. A January 2015, 94 strike call would cost approximately $11.30. To mimic a 500 share position, 5 call contracts would be purchased for a total of $5650.00 (this does not include commissions). This represents the maximum risk to the investor over the next year…approximately 12% of the underlying share value.
Like the protective put example, the stock must be trading above a specific break even point upon expiration of the calls or else the investor will incur a loss. Because the call option premium was comprised of all time value initially, the shares must be trading high enough to compensate for the time depreciation. As a result, the stock must be trading above $105.30 (the 94 call strike plus the $11.30 premium).
To compare the two strategies, both the protective put and the call option have a risk limited to 12 to12.5% of the underlying share value until January 2015. The break even point on expiration for both approaches fall between $105.30 to $105.75 per share. In addition, both strategies offer an unlimited profit potential.
The benefit to the call option buyer is that the cost to participate in the share appreciation is limited to the cost of 5 calls which is $5650.00. The protective put requires the purchase of the 500 shares at $94.00 for a total of $47,000.00 plus the cost of the 5 puts. This adds an additional $5650.00 for a total capital outlay of $52,875.00. The call position clearly offers the investor the benefit of participating with significantly less capital.
On the other hand, the share holder has the benefit of collecting dividends throughout the year. In addition, if the shares do not trade above the break even on expiration, the investor may continue to hold the position accepting the loss on the put protection, but continuing to hold the stock for future gain. The call buyer accepts the maximum realized loss and must consider the merits of re-entering the trade.
The bottom line is that in both strategies, there is a limited risk exposure capped at the cost of the option with an unlimited profit potential as the share value trades beyond the break even point. This limited risk and unlimited profit potential is only valid until the expiration of the option contracts in both cases. As a result we can make the observation that a long call option is synthetically a long stock position with a protective put. The investor must determine if the benefits of one out weigh the limitations of the other based on their own objectives.
It’s been some time since I talked about gold. Not surprising since I am anything but a gold bug.
But when you look at where some of the premier Canadian gold stocks are trading, even the most avid non-believer has to take a second look. Not that I recommend buying the miners in search of a turnaround, but as covered call writing candidates some of the stocks look interesting, particularly if you are willing to write longer term at-the-money calls.
Take Goldcorp (Symbol: G, Fridays close: $24.31), Agnico Eagle (AEM, $27.56) and Franco Nevada (FNV, $42.15) as examples. Goldcorp and Agnico Eagle are near 52 week lows and there seems to be some decent support at these levels. Franco Nevada has recovered from a low $33.05 and seems to be in a trading range between $35 and $50.
Covered calls on these stocks should be viewed as a way to generate cash flow in your portfolio. Options on gold stocks typically trade in the top quartile of all Canadian implied volatilities, reflecting their propensity to have above average intraday swings without really going anywhere over the longer term.
With that in mind, take a look at buying Goldcorp at $24.31 and writing the July 25 calls for a $2.60 per share premium. The stock pays a monthly dividend of 5 cents per share, which would generate the following returns over the next eight months; 15.18% if the stock is called away, 12.34% if Goldcorp stays the same. The premium plus the dividends lowers your breakeven on this trade to $21.3,1 which is below recent support.
Franco Nevada generates similar numbers if you bought the shares at $42.15 and wrote the July 44 calls at $4.15. When you include the 6 cent per share monthly dividend, the eight month return if called away is 15.37%, return is the stock stays the same is 10.98%. The downside breakeven on this trade is $37.52.
Finally, with Agnico Eagle you could look at writing the June 28 calls. AEM pays a quarterly dividend of 22 cents per share and you should get two dividends prior to expiry. Using these numbers the seven month return if called away is 14.80%, the return if the stock stays the same is 13.21% with a downside breakeven of $23.92.
I wanted to use this article to review and discuss the end result of the blog I wrote last month on Talisman Energy (TSX:TLM). While there was substantial options activity last month on the stock, our focus was on one particularly large trade which consisted of the selling of 10,000 put contracts of the November $12.50 strike. Obviously the high activity was a result of the shift in investor sentiment after Carl Icahn took a 61 million share purchase (6%) into Talisman.
Now that the November options expiration has come and gone, let’s compare the outcome of the put sale vs. an investor outright buying the shares assuming the puts were cash covered and unleveraged.
Here are the specifics:
- 10,000 puts represent a 1,000,000 share play on the stock at the $12.50 strike.
- The option was transacted at $0.48.
- The stock was trading in the $12.70-$13.00 range at the time of the block trade.
The put selling investor had an obligation to buy Talisman shares at $12.50 over the 4+ weeks to the November 15th expiration. Having collected a $0.48 premium, the average cost base on an assignment would have been $12.02 which is $1.81 (13%) lower from its peak price of $13.83. The investor collected $480,000.00 cash flow (3.84%) for having taken the risk.
Now that we know that those puts profitably expired, we wanted to compare the outcome of the puts to the alternative of having bought the shares outright.
- Hypothetically purchased 1,000,000 shares at $12.70 on October 9th 2013.
- Would have received a $0.071 dividend on November 14th.
- The stock is trading at $12.80 on the morning of November 18th.
- The share investor has $0.10 in unrealized gains and received $71,000 in realized dividends.
- The investor had all the immediate downside risk from the $12.70 price.
The Seller of the Put:
- Had an obligation to potentially have to buy 1,000,000 shares at $12.50 until November 15th.
- Originally received $0.48 premium or $480,000 for undertaking the obligation to buy.
- The stock closed above the $12.50 strike and the puts profitably expired realizing the $480,000 profit.
- Because the premium was received immediately, the investor only had downside risk below the average cost base of $12.02 or $0.68 (5.35%) less than the share investor.
When reviewing the different outcome possibilities, the only scenario in which the share buyer had any benefit was if the stock had a material advance higher above $13.18. Under the scenarios where the stock stayed the same, (like it did), the put seller came out ahead by over $400,000 after accounting for the dividend. At the same time, if the stock was to have unexpectedly dropped, the put seller would have bought the shares over 5% cheaper than the share buyer.
So when comparing the two approaches, the put seller clearly has an advantage of creating consistency and less volatility, while the stock buyer has the opportunity for extraordinary gains but is far more vulnerable to immediate downside risk and short term volatility.
This week I’m looking at TransAlta (TSE:TA) as a buying opportunity. Not only did TransAlta options make the most active list last week, an analysis of the price chart reveals a number of technical attributes supporting a continuation to the upside for the stock.
TransAlta is a non-regulated electricity generation and energy marketing company with businesses in Canada, the United States, and Australia. Their business includes the generation and wholesale trade of electricity and other energy-related commodities and derivatives.
TransAlta’s diversification of resource markets include:
- natural gas
If you are not familiar with all of the technical observations above, the main consideration is that there has been a shift in the primary down trend that has been respected since the beginning of the year. In addition, prices are now holding above the near term average and momentum is building to the upside. For a longer term confirmation of a possible change in trend, investors can overlay a 200 day moving average. Prices closed above this long term trend indicator this past week.
TransAlta is yielding an attractive dividend. According to TransAlta Shareholder Information dividends are paid January, April and July and October. The payout to date has been $0.29/share, which represents an annual yield of 8% as of Friday, November 15th close of $14.50. With prices bouncing off historical lows and technicals suggesting a possible upswing, the timing might be right to consider buying shares. An investor who wishes to pick up the next dividend would need to own the shares before it goes ex-dividend which is November 27th for payout on January 1st, 2014.
The options market offers a strategy to help meet almost every objective. For example, an investor who is focused on enhancing yield could integrate the covered call strategy.
The below option chain reflects option premiums as of the close on November 15th. The last price of the June 2014, 17 strike call was $0.20.
While the covered call writer may be able to get a better fill based on the bid and ask spread, a passive investor focused on income may consider selling the June 17 strike call to bring in some additional cash flow.
By choosing the June 2014 expiration, the investor will be less transactional as the call expires in 213 days. This means that the investor will not have write new calls month after month and is less concerned about assignment as the strike is several dollars away from the current stock price. This allows for an appreciation in share value by 19% and brings in another 1.5% yield which would annualize to approximately 2.5%.
The investor now has the potential to increase the yield on the TransAlta shares by 10.5% while benefiting from an appreciation in share value. Over the time period, if the investor is concerned about short term risk, a protective put could be purchased to hedge the downside using a portion of the cash flow generated through dividends and call writing.
To potentially increase the return on the covered call portion, the investor may sell shorter term, closer to the money calls. The risk with this approach is the potential for assignment before the dividends are collected as well as the increased transaction costs do to the more active writing.
Back on October 15th, I wrote about some unusual activity on Tim Hortons options that caught my eye earlier in the week. At the time, I hypothesized that a trader may have created a position to take advantage of the earnings report scheduled to be released on November 7th. While I will provide a brief review of the strategy below, you can read the full post here Tim Hortons Serves Up Some Unusual Activity
On October 9th, Tim Hortons (TSE:THI) shares closed at $59.70. On that day, there were over 2000 November 62 and 64 strike calls traded as well as 500 each of the November 56 and 54 strike puts. I will caution, as I always do, that it is difficult at best to determine exactly the intention of the trader or traders as there is no indication as to whether these contracts were purchased or written, or whether they were all part of the same strategy. With that in mind, I suggested that an advanced options trader could create a bullish position at a reduced cost by purchasing a Bull Call Debit Spread. To reduce the cost even further, a Bull Put Credit Spread could also be executed.
With the shares at $59.70, the Bull Call Spread would be constructed as follows:
- Buy the November 62 strike calls and pay $0.65
- Sell the November 64 strike calls and collect $0.28
- Net debit = $0.37
- Max profit = $1.63 ($2.00 spread minus the premium)
- Break even on expiration = shares at $62.37
Assuming 2000 spreads were executed, this would be a cost of $74,000.00 for a profit potential of $326,000.00
The Bull Put Spread would be constructed as follows:
- Sell the November 56 strike puts and collect $0.35
- Buy the November 54 strike puts and pay $0.19
- Net credit = $0.16
- Max Risk = $1.84 ($2.00 spread minus the premium collected)
- Break even on expiration = shares at $55.84 (56 strike minus premium collected)
Assuming that 500 spreads were executed, a credit would be received of $8000.00, but an additional risk of $92,000.00 is added.
All things considered:
The cost of the combination would be the $74,000.00 debit - $8000.00 credit = $66,000.00
The risk is increased due to the Credit Spread and is determined to be:
$74,000.00 ( debit)
+ $ 92,000.00 (credit spread differential minus credit)
This would be incurred if the shares are below $54.00 on expiration.
So, we can assume that the maximum risk on the trade is $166,000.00 for a maximum profit potential of $326,000.00
Tim Hortons released earnings on November 7th and Judy McKinnon of the Wall Street Journal reports:
- Third-quarter profit climbed 7.5% on stronger overall revenue and same-store sales growth in both Canada and the U.S.62
- Stronger results came despite what it said was a challenging operating environment.
- Same-store sales in the U.S. were up 3.0%, while Canadian same-store sales rose a more muted 1.7%.
- Earnings climbed to 115 million Canadian dollars ($110.4 million), or 75 Canadian cents a share, from C$107 million, or 68 Canadian cents a year earlier.
- Results in the latest quarter were hurt by a C$2.9 million asset-impairment charge related to under performing markets in the U.S. Year-earlier results included C$8.6 million of corporate reorganization expenses.
- The Thomson Reuters mean estimate was for a profit of 77 Canadian cents a share.
- Revenue rose almost 3% to C$825.4 million. Analysts were expecting revenue of C$824 million.
Shares rallied into the earnings release, however despite positive numbers, TSE:THI pulled back from a high of $63.86 on October 28th to settle at $62.55 this past Friday, November 8th.
With earnings behind us, there are a few important trade management considerations. Since expiration is next week, there is significant risk that the shares may continue to drift lower devaluing the Bull Call Spread. It would be wise for the trader to lock in profits or risk losing them.
As indicated above, the original debit was $0.37. A look at the closing prices on Friday reveal the 62 strike call bidding $0.68 and the 64 strike asking $0.08. Based on these values, the spread could be closed at $0.60 for a 62% gain.
It should be noted that prior to the earnings report, TSE:THI traded at a high of $63.86. Regardless of the intention to play the earnings, a prudent trader would look at an opportunity to lock in profits ahead of the announcement as a good risk management decision. Clearly, it is not likely that the trader is going to pick the exact high before the earnings, but for the sake of this example, with the stock hitting $63.86 on October 28th, the 62 strike was bidding at $1.99 and the 64 strike calls were asking $0.88. The spread on this date could be offset for $1.11 representing a 200% return.
What about the Credit Spread?
You will recall we made an assumption that a Bull Put Spread was constructed as part of this combination. The intention being to bring in some additional premium to help offset the cost of the trade. With the shares trading above the November 56 strike written as part of the credit spread, the options have a high probability of expiring worthless. In this scenario, the trader can keep an eye on the share price for the remaining week and buy the spread back only if the 56 strike is in jeopardy of expiring in the money.
Assuming that this was indeed the strategy executed, the trader has managed to meet their objectives and is now in a position of profitability. The bullish directional position was created with a limited and identifiable risk. While the intention may have been to hold the trade through earnings, if the position is profitable prior to, it is often best to consider closing a portion, if not all of the position. As history has taught us, earnings can surprise, and not always in the direction anticipated.
Just getting back from holidays makes this a great time to do some follow up on past trade ideas. Most notable among them being the calendar spread on Suncor (See “Calendar Spreads Trough October” - Sept 30–2013).
The suggestion was to sell the Suncor November 38 call at 75 cents while simultaneously buying the Suncor January 38 call at $1.30 for a 65 cent debit. The November calls expire next Saturday, and with the stock trading below $37 they will most likely expire worthless.
Assuming Suncor remains in a tight trading range around $37 per share, the January calls will undoubtedly be worth more than the initial 65 cent debit. At that point you could sell the January 36 calls and take a small profit, or you could write December 38 calls to capture a second premium.
In September 16-2013 (see “Covered Calls on Gold Miners”) I talked about writing covered calls ion Goldcorp (Symbol AEM, Friday’s close $25.71) and Agnico Eagle (AEM, $30.68). The Goldcorp covered call is slightly underwater, although I suspect the shares will be above the $28 per share strike price by the January expiration. AEM, on the other hand, is in-the-money and will likely get called away in December at $28 per share.
On September 9, 2013 I re-visited Blackberry (symbol: BB, Friday’s close $6.84). I suggested buying the BB December 11 straddle for a debit of $3.00 per share. The Dec 11 straddle closed Friday at $4.20 per share. Given the controversy surrounding BB I would take profits on the initial position (return is 40% in about two months.
On August 26-2013 (See “Why I like Banks”) and September 2, 2013 (“Sweet Spot for Canadian Banks”) I offered my very bullish outlook for the Canadian banks. In the September 2, 2013 blog I talked specifically about buying six month at-the-money calls.
The following table shows the results from those trades as of the close of trading on Friday. The three left columns show the return had the shares been purchased, and the three columns to the right show the returns from buying the at-the-money calls in early September.
Symbol 23-Aug-13 8-Nov-13 Return 23-Aug-13 8-Nov-13 Return
BMO $ 66.11 $ 72.76 10.06% $ 3.20 $ 7.15 123.44%
BNS $ 58.50 $ 64.24 9.81% $ 2.25 $ 4.35 93.33%
CIBC $ 82.26 $ 89.10 8.32% $ 3.80 $ 7.40 94.74%
RY $ 64.90 $ 70.31 8.34% $ 2.65 $ 4.85 83.02%
TD $ 89.62 $ 96.61 7.80% $ 3.50 $ 6.70 91.43%
NA $ 81.59 $ 91.57 12.23% $ 4.00 $ 9.75 143.75%