A Eurozone Play

On January 15th, the Swiss National Bank (SNB - Switzerland’s central bank) removed its’ self-imposed restrictions on the Swiss Franc. A major shift in policy shrouded in secrecy at a time when central banks had been trying to be more transparent, which many felt would have dire consequences for the Swiss economy. Note the quote from Nick Hayden Chief Executive of Swatch a major Swiss exporter who opined at the time; “Today’s SNB action is a tsunami; for the export industry, for tourism, and finally for the entire country.”

The fallout from the SNB announcement was immediate. The Swiss Franc rallied 30% against the euro and companies like Swatch fell 16% as the cost of their goods destined for European buyers surged 30% in an instant. The Swiss stock market declined a precipitous 7% in one trading day.

Makes one wonder why a powerful central bank known for its conservative mind-set would appear to act so recklessly. It turns out that the SNB was caught between the proverbial rock and a hard place. It simply had no choice.

It was 2012 when the SNB initially pegged the value of the Swiss Franc at 1.20 to 1.00 euro. The self-imposed ceiling was intended to halt the Swiss Franc’s appreciation which was, among other things, causing problems for Swiss exporters. In hindsight, the January 15th SNB decision was a precursor to a €1.6 trillion bond buying program (i.e. quantitative easing or QE) announced by the European Central Bank (ECB).

As expected the euro immediately fell against the so-called safe have currencies such as the US dollar and of course the Swiss Franc. Clearly the SNB felt that it did not have the resources to defend its 1.20 to 1.00 euro peg against currency traders engaged in a flight to quality. Interestingly, all of this has taken place before the ECB has even begun printing the necessary euros to fund its’ bond buying endeavours.

Beyond the currency impact, I think the ECB has created an interesting opportunity. After two years of skirting the issue, the ECB has embarked on a program that will ultimately do what Mario Draghi has always said he would do; defend the Eurozone at any cost!

That is not to suggest that we will see a bump in Eurozone economic activity because, like the US experience, I suspect the ECB bond buying program will end up strengthening the balance sheets of European banks and probably light a fire under the various Eurozone stock markets by expanding P/E multiples and bolstering stock re-purchase programs.

To that point, traders are reminded of the 2013 rally in US stocks following the October 2012 announcement by the US Federal Reserve of QE-III. Since the ECB’s program is similar in size to QE-III, we may see some decent gains in European stocks during 2015.

The challenge is to take advantage of a surge in European stocks while hedging out the risk of a declining Euro. One product that comes to mind is the iShares MSCI EAFE Index ETF (symbol XIN, Friday’s close $24.48). XIN is not a pure play but it does provide exposure to European stocks and hedges the currency back to the Canadian dollar.

XIN has already rallied 9.97% since the beginning of the year but I think there is more to come. I note for example that money managers are warming to the idea of a stronger Eurozone in 2015. More than a few have opined that European stocks look relatively inexpensive when compared to the S&P 500 Index. And with the bond buying program just beginning, we should see it impact Eurozone stocks as the snow begins to melt.

Aggressive option traders might consider buying some longer term in-the-money calls to take advantage of this scenario. Specifically look at the XIN September 24 calls at $1.25.

Hedging the Currency Impact on Canadian Stocks

Canadian investors started the year with a pleasant surprise as the Canadian market and many Canadian stocks performed relatively well.  We suggest a little digression to understand the precipitating factors that have driven this rise.
Over the last 6 months, we have seen a dynamic shift in Canadian economics.  Canada has been relying heavily on the resource sectors to drive the wealth of the nation.  As the resource, particularly the energy sector, plummeted over the last half year, a number of significant concerns were exposed.  One only has to look to the Bank of Canada (BoC) and its significant shift in monetary policy to understand the need for immediate action to stabilize the situation. Without going into the specifics, the key observation that must be observed is the divergent monetary policy between the Federal Reserve and the BoC.  This divergence has been one of the key drivers in the substantial decline of the Canadian dollar. This currency trend has been significant enough to make a material impact on equity prices in the Canadian market.
In fact, one can attribute much of the rise in the Canadian stock market to the serious decline in the purchasing value of the Canadian dollar.  To give a few examples:

Canadian Market:

  • iShares MSCI Canada Index Fund ETF (US Dollars) – Year-to-date: -(2.30%)
  • ishares S&P/TSX 60 Index ETF (Canadian Dollars) – Year-to-date: +4.50%


  • BCE shares traded in New York (US Dollars) – Year-to-date: - (3.78%)
  • BCE shares traded in Toronto (Canadian Dollars) – Year-to-date: +3.12%

If you are like the average Canadian investor, you are overweight Canadian equities in Canadian dollars and due to the decline in our dollar; we have seen a currency induced/adjusted advance in equities.  In order to remain strongly bullish Canadian equities, you have to believe in one of two themes.  One, there is a strong economic recovery around the corner for the Canadian economy, or two, the currency will still make a considerable decline towards $0.75 or $0.70 against the U.S.   If you are in one of those camps, you can stay long.  But if you believe the majority of the currency move is behind us and that the Canadian economy will struggle in the year ahead, this is a great time to employ yield enhancing strategies.
One yield enhancing strategy is to sell out-of-the-money covered calls for a longer duration like 6-12 months. These premiums allow you to create returns without needing further appreciation in the underlying stocks.  In addition, the premium received can act as a hedge to reduce the volatility of your portfolio.
As an example, the XIU – iShares S&P/TSX 60 Index ETF, is trading at $22.61.  That is over 10% higher off its $20.50 lows in January.  An investor that feels there is only marginal upside can sell a September $23.00 covered call is bidding $0.60 or 2.65% cash flow premium.
This is only a good idea for those investors that remain skeptical of the further upside of the Canadian market. At minimum, it is a strategy that could be actively deployed in the upcoming months once the market momentum has started to slow into the historically weak summer months.

Catching a Falling Knife

Back at the end of January, Richard Croft posed the question “Has Oil Bottomed?“.  At the time of publishing, oil was trading at around $46.00 per barrel.  In his article, he cites a number of supply and demand and geo-political considerations supporting the potential for range bound trading activity between $40.00 and $60.00 per barrel through out 2015. He offers the covered call strategy as a way to take advantage of increased option premiums due to volatility and enhance cash flow as some of the big name energy companies share prices  consolidate and advance slowly higher.

This is a great approach for a more passive investor. However, I think there may be an opportunity to take advantage of a short term upswing in oil for the more active reader.

In addition to Richards considerations, I would also look at the trend of the U.S. Dollar.  If we plot the U.S. Dollar Index against Light Sweet Crude Oil, you will notice the inverse relationship of the two.  Since commodities in general are priced in U.S. Dollars, when the USD is strengthening, commodities tend to weaken and vice versa.  Of course, from time to time, supply and demand forces and geo-politics will exert an influence. However, the weekly chart below clearly reflects the inverse relationship.

USD against Oil Weekly

With this in mind, we need to recognize that the strength of the U.S. Dollar has been largely influenced by the uncertainty in the Euro.  The European Central Bank decision to launch a U.S. style quantitative easing program forced a continuation lower in the Euro. However, in spite of the recent Greek elections and the looming threat of a Greek exit from the Euro-zone, it appears as though the Euro has priced in the threat.

My expectation is that the Euro is due for a retracement, and while we are not likely to see a change in the longer term down trend, we should see traders covering profits and short-term bulls jumping in and buying the up-swing.  This will force the U.S. Dollar lower as a reciprocal currency.  As the U.S. Dollar retraces lower, we should see a jump in commodities and more to the point of this article, oil. Traders have been benefiting on the short side of oil.  As it becomes more evident that a short term bottom may be in place, there will be a period of short covering, which I suspect has already started.  Short covering involves the buying back of the short position, which creates demand and influcence prices higher.  This can often be a very volatile process.

The challenge is that with so much uncertainty in world of geo-politics and the currency wars raging on, calling a short term bottom in oil is like trying to catch a falling knife and I would add, a slippery one. However, the business of trading and investing is all about risk and reward.  It is impossible for us to predict where the exact bottom of oil is but if we believe that there is the potential for a move higher, taking a decisive stance at current levels may yield an attractive return. Over the near term we can look at using a call option to gain exposure while limiting the risk to a defined amount if we are wrong.

HOU is the Horizons BetaPro Nymex Crude Oil Bull Plus Fund ETF.  This Exchange Traded Fund provides the investor with a 200% exposure to the daily performance of light sweet crude oil futures.  Now, this is a leveraged ETF which means that it can be volatile both in potential gains and potential losses.  For more details on this product you can visit the  Horizons BetaPro Nymex Crude Oil Bull Plus Fund ETF info page.

Using an 8 and 21 day Exponential Moving Average we can see that the prices of the HOU are starting to consolidate above the lines.  This is something we have not seen for quite sometime. It is an indication that there is a potential change in trend taking place.

HOU 02_17_2015

To take a “shot” at a continuation to the upside with a limited and identifiable risk exposure, you could consider a June $10.00 call on TSE:HOU for $1.70.  With the shares currently trading at $9.55, this would be an at-the-money option.  This move higher could happen over a much shorter time horizon. However, given the volatility and uncertainty of the oil market, allowing for several months for the trade to play out offers the trader a certain level of comfort.

Keep in mind that this is not a “buy and hold” type strategy.  As the shares of TSE:HOU move towards the $15.00 range, it would be appropriate to consider locking in profits.  This approach offers the active investor a way to take a decisive stance on a move higher in oil, with a limited and denifiable risk exposure and without limiting profits

Hedging Interest Rate Risk

This past week we saw some indications that longer term interest rates may actually rise. Something investors have been talking about for the past two years!

It is not that interest rates will rise significantly, it is more about what impact any change in mindset will have on your portfolio. More importantly, what steps can one take to manage interest rate risk?

What we know is that higher interest rates mean lower bond prices. Think about interest rates and bond prices as opposite ends of a teeter totter. Duration also plays an important role as longer term interest rates and bond prices will be more volatile than shorter term rates and prices i much the same way as a longer teeter totter moves more dramatically than the shorter version.

Higher interest rates do not affect stocks in the same way. Insurance companies for example, may be hurt by rising rates if they have a significant portion of their investment portfolio geared to annuities. Mind you that depends on whether annuitant recipients have options in terms of exiting contracts. On the other hand, it helps their life insurance business because they can earn higher returns on the portion of their capital tied to death benefits.

If interest rates do rise significantly, it can have a negative impact on auto dealers and furniture companies who have to pay higher costs to maintain their inventory. On the other hand, it would have little impact on grocery store chains that turn over inventory rapidly.

Banks typically benefit from higher interest rates especially if rates rise faster on the mid to longer end of the yield curve. Banks typically borrow money at the shorter end of the curve to finance mortgages at the mid to longer end of the curve.

We witnessed some of the advantages from higher rates flow through to Canadian banks over the past week. All of Canada’s major banks turned in some decent performance and I suspect we will see more of the same over the next few months. With that in mind banks provide the twin benefits of an excellent hedge against the possibility of higher rates and solid dividends should you have to buy and hold. Any of Canada’s major banks would fit the bill if you buy into this scenario.

A couple of ways to play this; 1) buy the shares and write slightly out of the money calls with two to four months to expiry or 2) for more aggressive traders take a look at buying longer term calls for capital appreciation with limited risk.

As an example you could look at buying shares of Bank of Montreal (symbol BMO, Friday’s close $78.69) and writing the April 80 calls at $1.70. The two month return if exercised is 3.83%, return if unchanged is 2.16% and downside protection is $76.99.

The other option is to buy BMO January 78 calls at $5.40. These calls are 89 cents in-the-money and will be profitable if BMO is above $83.40 by the end of the year. They may also be profitable in the interim should BMO spike on any news of higher rates.

Consumer Skepticism

A number of the big name oil companies are reporting earnings this week and many analysts think that the numbers may be worse than expected, which is to say worse than numbers that have already been revised downward.

Still, this is one case where you might want to take the numbers with a grain of salt. Let’s face it, tighter margins and lower earnings will reflect what everyone already knows. Despite one day surges like we saw last week, oil is unlikely to move substantially beyond its current US $40 to US $60 trading range for the remainder of 2015.

In my mind, the real story is how consumers have shrugged off lower oil prices. In my last column, I posited that North American consumers may have caught the savings habit and while that is one explanation, there is another possibility. It may be that consumers’ predilection to save has more to do with disbelief than a desire to strengthen their balance sheets. In other words, consumers are reluctant to accept that oil prices will remain at these depressed levels.

The longer oil remains within its current trading range, the more likely consumers will suspend their skepticism. That could lead to a surge in consumer spending in the second or third quarter of 2015, which would go a long way towards providing the kind of oomph that the economy needs. And by the way, be positive for North American equities.

Another consideration that should be factored into this mix is the Bank of Canada’s (BOC) recent interest rate cut. Clearly the BOC is comfortable with a low Canadian dollar, which, in the long run, keeps our exports competitive at a time when the rest of the world – the Eurozone, Japan and China – is engaging in all out currency wars.

What we have then is a triple threat;

1) consumer skepticism

2) low interest rates

3) a weak loonie

A couple of companies that can benefit as the threats dissipate are Canadian National Railway (Symbol: CNR, Friday’s close $83.72) and Canadian Pacific (CP, $221.81).

If this is a second half story, speculative traders might look at buying calls on these companies. The CNR September $84 calls at $6.10 (implied volatility 22%) and the CP July $220 calls at $19.10 (implied volatility 27%) look interesting.

You could also consider bull put spreads as the calls may be a bit too pricy for some traders. With CNR, you could sell the September $84 puts at $6.50, while buying the September $76 puts for $3.30. This spread generates a net credit of $3.20, which is if the stock closes above $84 in September causing it to expire worthless. The maximum risk will occur if the shares close below $76 in September. In that case, you would be required to buy shares of CNR at $84, but would have the right to sell the shares at $76. The maximum risk is the difference in strike prices, $8.00, less the net $3.30 credit received or $4.70 per share.

With CP, you could sell the July $220 puts at $16.25 and buy the July $200 puts at $8.75. Assuming you can get these prices, the spread generates a net credit of $7.50. If CPP closes above $220 in July, both options will expire worthless and you will retain the net credit. The maximum risk occurs if the shares close below $200 in July. In that case, you would be required to close out the position at a price of $20 per share, which would be a loss of $11.25.

What About The Banks?

Since my colleagues have already discussed Canadian Investors’ favorite topics, oil and gold (see Has Oil Bottomed? By Richard Croft and Is the Divergence in Gold and Opportunity? by Patrick Ceresna), I thought I would take a look at Canadian banks.

Canadian banks have no doubt come under pressure, dropping an average of 15% from the re-test of the 2014 highs, back in December, to their recent lows.  Most of this can be attributed to investor concerns over the fall out from declining oil prices. Concerns have been based on an expected disruption in several lines of business. This includes a decline in underwriting revenues, derivatives risk exposure and possible default in uninsured mortgages, home equity lines of credit and credit card payments in the oil producing provinces.

To add to the pressure, the Bank of Canada lowered interest rates by 25 basis points last week.  As a result, Canadian banks lowered their lending rates. The issue with this is that the banks rely on the spread between what they can borrow at versus what they can lend at.  As key interest rates drop, the spread tightens and profits suffer.  Interestingly enough, the 6 major banks only adjusted by 15 basis points in an effort to protect the already low lending margins. In addition, forecasts are pointing towards lower economic growth in 2015, which further adds “fuel to the fire”.

Investors have a habit of over compensating for the unknown.  While there are still many unknown variables, it does appear as though bank share prices in general may be stabilizing at these current levels.  Let’s take Toronto Dominion for example (TSE:TD). According to marketwatch.com, many analysts are rating TD as a buy and share prices appear to be finding some support at $50.00, which is a previously tested low.  As a side note, the charts look considerably different on the NYSE due to the currency consideration.  A factor that deserves significant attention as a Canadian investing in U.S. securities.

With TD earning due out on February 26th, we will see just what impact the lower oil prices and poor economic forecasts have had on the companies last quarter.

Many investors are motivated to own Canadian bank shares because of the stable dividend stream they provide.  However, with uncertainty looming, using a call option as a stock replacement strategy offers the investor the right to own the shares at these depressed prices with a limited risk exposure.  While the option buyer does not have the right to the dividend, it is important to note that dividends are already priced in to the value of the option. This actually reduces the cost of the contract from what it would be if the stock did not issue a dividend. In addition, the potential risk of holding the underlying shares may not initially be worth the 4% dividend yield.

With this in mind, we could look at purchasing a call option on Toronto Dominion (TSE:TD) ahead of the February earnings.  In this example, I want to look at holding a longer term position in TD into 2016.  This will allow me to benefit from any share appreciation over the year, but limit my risk exposure to a fixed amount during times of uncertainty.  If the shares take off at any point and are trading above the strike price I have selected, I have the right to take possession of the stock.

With TD shares trading at $51, we could purchase a call option at the $52 strike price expiring in January 2016 for $2.99 per contract.  This represents our maximum risk on the shares for almost an entire year.  It is important to note that our break-even point is $55 per share. This means that on expiration, the shares must be trading above $55 for the position to be profitable.  By using the option as a stock replacement strategy, we limit our risk on the shares to approximately 6%, when considering today’s prices. Compare this to an unidentified risk exposure for the out right share holder.

If, for example the shares finish the year at the previous high of $58.00, the option would have an intrinsic value of $6.00.  This is determined by subtracting the strike price of the option ($52) from the settlement value of the stock ($58).  This reflects a 100% return on risk.

For the income focused investor, outside of your registered accounts, you can implement the calendar spread strategy.  While holding the longer term call option, you can sell out-of the-money calls to generate a monthly cash flow as you would in a covered call strategy.

For example, while holding the January 2016, $52 strike call, you could sell the February $54 strike call for $0.20.  If you can collect this kind of premium on a regular basis, you will significantly lower the average cost of your longer term option and subsequently reduce your break even point on the shares.

The trade off with this approach is that if the shares jump beyond the written strike, you may be assigned to deliver them.  In the example above, as the stock approached $54, the investor may be motivated to buy the written call back and roll the position by selling a call at a higher strike and further out expiration date.

If you are interested in owning TD at these levels, consider the longer term call option purchase as way to gain exposure with a limited and identifiable risk for almost an entire year.  Of course if shares continue lower the option always be sold for a partial loss rather than holding out until expiration and risking the option expiring worthless.

Regardless of how you manage or modify the position, the longer term call option offers the investor the ability to take a decisive stance on a stock and weather some of the short term uncertainty with a limited and identifiable risk exposure.

Has Oil Bottomed?

Trading in the first quarter of 2015 will center on oil for good reasons. Not only has oil’s fall created one of the largest tax cuts since Reaganomics, the fallout has far reaching implications across a broad spectrum of industries.

Interestingly, at US $105 per barrel, it was obvious to anyone who understood supply and demand that oil was overvalued and demand will not likely drive oil prices higher as it is at best, stable with a slow bias to the upside.

Supply on the other hand has been rising at an almost exponential pace. Particularly as fracking technology has allowed the US to get at supplies that were previously unattainable. There is a view that U.S. and Canadian operations may be taken off stream as prices continue to decline. At present, most of the major wells remain in play likely because the estimated cost of production is somewhere between US $30 and US $45 per barrel. This is not as profitable based on recent prices, but margins that are sufficient to maintain current drilling operations.

The question is where do we find a bottom? My best guess is that we may have already put in a bottom and will likely trade in a range between US $40 and US $60 per barrel throughout 2015.

The one view everyone seems to share is that oil price declines benefit consumers. Perhaps, but those benefits seem to have been misplaced as consumers were reluctant to spend over the holiday season. Is it possible that consumers in the US and Canada have developed a savings habit?

We also know that a disruption within any sector leads to a domino effect across the economy often with unpredictable consequences! For example, we know that the Russian economy is imploding. That’s a dangerous environment when you have powerful politicians seeking to retain power in a declining economy that has no safety nets.

Veteran traders may recall April 2nd, 1982 when Argentina laid claim to the Falkland Islands, ultimately sparking a ten week war with the United Kingdom. The Falkland War was not about claiming territory in the South Atlantic, it was about deflecting attention away from the hyper-inflation that lead to rioting and civil unrest within Argentina. In the end, Argentina suffered a major defeat on the battlefield but got its desired result by focusing the country’s attention on the war effort and away from domestic problems. I am not suggesting that Russia will engage in the same kind of mind games,but you have to think that Ukraine is a potential pawn should things worsen.

The same story is true in Venezuela, that has already imploded and will most certainly face civil uprisings. More importantly, the Middle East, where major producers like Saudi Arabia have enormous fixed costs that cannot be honored unless the country continues its current output regardless of the longer term consequences!

On the positive side, we have seen movements in Iran away from their nuclear ambitions, which is clearly driven by their desire to further the domestic agenda in an environment of lower oil prices. In fact, we may see a politically motivated agreement forged in the months ahead that only six months ago would have been impossible.

On an economic level, there is no doubt that oil producing regions of the US will suffer as will the Canadian economy given oil’s roles as one of the three pillars that drive Canadian GDP. However, it may not matter much when you consider the power that oil wields on the political stage.

Oil is one of the world’s great equalizers. Long employed by oil producing countries to influence their political agenda, I suspect the US will be reluctant to ratchet down production for fear of losing a big stick.

When you think about it in those terms, it is clear that the US has been wielding a big oil stick with some clear results. As mentioned, Russia is imploding based on the fall of the Ruble, Venezuela’s economy is on the verge of collapse and the OPEC countries no longer have any real influence on the world markets.

Same goes for the US fight against terrorism. The best way to stop a radicalized fringe groups is to stop funding them. As North America becomes less dependent on foreign oil, it creates an interesting political backdrop to enact these types of policies.

If we accept the twin premise that oil has 1) put in a bottom and 2) is unlikely to rise sharply during 2015, traders may want to look closely at covered call writing on some of the larger energy names. The recent volatility that has sent option premiums higher across the energy sector make this strategy especially appealing.

Some stocks to consider as covered writing candidates; Crescent Point Energy (Symbol: CPQ, Friday’s close $30.07). Selling the April $32 calls at $1.65, Canadian Natural Resources (CNQ, $35.51), selling the May $36 calls at $2.90 and Imperial Oil (IMO, $47.43) selling the May $48 calls at $3.20.

Is the Divergence in Gold an Opportunity?

Gold has drawn my attention this month, not just because of the rise, but the conditions from which the rise is occurring.  I pride myself on being a student of intermarket relationships within the markets.  One of the key pillars of intermarket analysis is the understanding of the inverse correlation of the U.S. Dollar to commodities.   This could not have played out in a more clear way in the second half of 2014.  July 2014 marked the bullish breakout of the U.S. Dollar and marked key commodity downturns in oil, copper, uranium, iron ore, gold and many other commodities. This marked a distinct bear market drive in almost all commodity based stocks.

As the U.S. Dollar rose throughout the second half of 2014, gold declined $200.00 an ounce from $1340.00 down to a low below $1150.00.  But the New Year has brought about an interesting divergence.  Driven by 1000 pip ($0.10) drop in the Euro, the U.S. Dollar has been very strong to start the year.  This has caused a further $10.00 decline in oil prices and a $0.40 further decline in copper prices.  With all things considered, the correlation in gold would have naturally allowed it to weaken down to the $1100.00 area.  But it didn’t.

Instead we have seen gold stabilize and bullishly advance over $100.00 an ounce over that timeframe.  These types of divergences draw my attention.  This implies to me that the uncertainty in regards to a global recession and new ECB quantitative easing policies is drawing attention to gold as a hedge.  As we now see zero to negative interest rates in the stable parts of Europe, holding 0% yielding gold bullion is a viable asset to hedge currency risk.

It is premature to be hyping a new gold bull market, but with gold and gold stocks being so depressed over the last 3 years, there may be room for them to retrace some of the overdone selling.  The traditional way for investors and traders to participate in a trade like this is to buy a gold ETF like the iShares Gold Bullion ETF (CGL) and/or the iShares S&P/TSX Global Gold Index ETF (XGD).  My observation as a trader is that the ETFs alone do not make the trade asymmetric enough.  This is where I like to consider an in-the-money call option as a high delta way to participate.

Let’s compare the purchase of shares vs. call options with a $4.00 rise in the XGD stock.

  • 1st investor buys 1000 shares of the XGD for $11.34 or $11,340.00 investment.  The investor has an undefined downside risk if the trade idea is wrong.   If the stock was to rise to $15.34, the investor would be sitting on $4,000.00 in paper profits.
  • 2nd investor buys 10 March $10.00 call options for $1.57 or $1,570.00 which gives the investor the right to buy 1000 shares over the next 2 months at $10.00 per share.  If wrong, unlike the undefined risk of the stock investor, the absolute worst loss the investor can incur is $1570.00.  If the stock was to rise to $15.34, the call would have a $5.34 intrinsic value. This would be a $3.77 profit per share or $3,770.00.

Many traders like to look at the option trade as a 200% gain, but I don’t look at it that way.  I look at it from the perspective that I was able to get an almost dollar for dollar participation (high delta), while being able to manage and define my risk.  In March, the investor has the choice to take profits or to exercise the calls and take ownership of the ETF for the long term.  To me, this represents a compelling alternative to just buying the stock.

Weekly Options Now Available in Canada

I had the pleasure of presenting at the Toronto Options Education Day back on September 27th, 2014.  The topic was “A Guide To Weekly Options”.  Even though the contracts had yet to launch the interest was overwhelming and many traders and investors have been patiently waiting to access this new product since then.

Well the wait is over, the Montreal Exchange has officially launched weekly options on the following stocks:

  • Barrick Gold Corporation (ABX)
  • Blackberry Ltd (BB)
  • Encana Corp (ECA)
  • Goldcorp Inc (G)
  • Ishares S&P/TSX 60 index ETF (XIU)
  • Potash Corp of Saskatchewan (POT)
  • Royal Bank of Canada (RY)
  • Suncor Energy Inc (SU)
  • Toronto Dominion Bank (TD)
  • Yamana Gold (YRI)
These options have the same contract specifications as a standardized monthly contract except that they are introduced on a Thursday and trade through to the close of the Friday of the following week. The main difference between Canadian weekly options and U.S. Weeklies is that only 1 Canadian weekly can be listed at any time unlike U.S. Weeklies which allow up to 5.
With this in mind, Canadian weekly options offer traders and investors a new approach to meeting their objectives.

Benefits include:
  • More choice for spreads and combinations
  • Cheaper premiums for greater short term leverage
  • More sensitivity to stock price movements for short term traders
  • Target specific events without having to purchase more time than needed
  • Protect positions against earnings by purchasing 1 week of protection versus one month
  • Enhanced cash flow for option writers with 52 expiration dates per year
Challenges may include:
  • Requirement of active management based on short term objectives
  • Little time to make adjustments due to accelerated rate of time depreciation
  • Less up front premium for the option writer
  • May be more commission intensive
Individual traders and investors will have to determine for themselves how, if at all, weekly options will fit into their plan.  I am not personally a “short term” options trader however I see significant opportunity in using these weekly options as part of an income strategy.
Income Generation
Using weekly options as part of a Covered Call strategy presents an opportunity to take advantage of the rapid time depreciation associated with a short term option contract.  This also allows the investor to evaluate expectations on the stocks performance over a short period of time and make adjustments accordingly.
Below is an example of Barrick Gold Corporation (TSE:ABX).  The important consideration is to compare the annualized rate of return for each option write.

Barrick Gold Corporation (TSE:ABX) shares at $13.21, 14 strike call write:
ABX Weekly Comparison

While the longer term option writes deliver greater up front premium and are less transactional, the annualized rate of return is lower than the weekly write.  With that in mind, the weekly option provides enhanced cash flow over the long term but offers less upfront premium.  In a primary bullish market, this may be a good trade off. However, if there is an expectation that the market may be volatile (to the down side) collecting more premium up front to mitigate the anticipated market volatility may be the best solution.

The bottom line is that weekly options have unique characteristics that make them a viable solution in certain situations.  It is up to the investor to determine where they fit into their plan.  I believe the more tools we have at our disposal, the more effective we can be as retail investors in navigating these markets. For more information on weekly options available on Canadian stocks visit MX Products>Weekly Options

Using Stock Cycles For Covered Call Writing

As a Chartered Market Technician I spend considerable time exploring the quantitative side of stock and broader market cycles to find periods of statistical advantage. For investors it is often simply trying to maximize the returns from a longer term holding. I have found that there is considerable value in enhancing investment yields through periodically and passively implementing covered calls.

Key tenants to this methodology are the open acceptance that stocks do not just go up in a straight line, but rather go through cycles of overbought and oversold conditions. If that can be openly accepted, then it becomes about identifying a measuring technique to quantify that cycle.

To illustrate, I will use BCE shares. BCE has been in a decisive bull market from its 2008 low of $16.85 to its current test of multi-year highs. A disciplined and patient investor has been well rewarded with a material capital gain and a consistently lucrative dividend income stream. But when one looks deeper into the cycles, investors may see value to seeking to enhance that return.

On the table below I simply identified where the stock price was relative to its 52 week mean average. What is identified is that over the last 5 years BCE has had 7 intermediate swing highs that, on average, occurred when BCE was trading $5.00 above its 52 week mean price. Each of these 7 periods the stock proceeded to consolidate lower or sideways an average of 185 days (6 months).

If an investor was to believe that there is statistical merit to that observation, then selling covered calls on the stock when it has reached an overextend state would enhance the yield income on a stock with limited short term upside potential.

Last week on November 21st, BCE had a closing price at $54.24, which was $5.96 above its $48.28 52 week mean price. Referencing the 7 past cycles, this suggests that BCE may be close to the upside of its current rise and there may be increasing value in writing a covered call at these levels.

  • At the time of writing (Nov 26, 2014), BCE is trading at $52.88
  • May $54.00 covered call is bidding $1.05 (1.99% cash flow)
  • May $56.00 covered call is bidding $0.50 (0.95% cash flow)

For an investor that owns BCE for the current 4.67% dividend income stream, selling a strategic covered call gives the potential to enhance that income to 5.50-6.50%. While there is no guarantee the stock cannot go higher and exceed the call strikes, an investor that looks at the probability associated with the rise may recognize it is far more probable that the stock consolidates after such a substantial rise. If a covered call was strategically written at each of these 7 prior peaks, the investor could have collected 5-15% addition income over the last 5 years.

Using options is an active strategy, that may involve having to sell the stock or buy back the option which makes the strategy more dynamic. But for an investor willing to be more active, the additional income may be worth the effort.