An option strategy that works well for those want to take advantage of time value is calendar or time spreads. It is also a good strategy in a low volatility environment. With the MX Volatility Index at 15.35% and well below its 200-day moving average there is a good argument in support of the position that volatility is low.

The calendar spread involves the purchase of a longer term call option combined with the sale of a shorter term call option. You could also use puts in a calendar spread, but the key with the strategy, is that both options have the same strike price.

You could create a calendar spread on the iShares S&P TSX 60 index fund (symbol XIU, Fridays close $17.77) by selling, say, the XIU March 18 calls at 35 cents, and buying the XIU March (2013) 18 calls at $1.45. Both options are calls with the same strike price. The difference, and why we call it a calendar spread, is the expiration months. The short call expires in two months (March 2012) while the longer term call expires in 14 months (March 2013).

The calendar spread has an out-of-pocket cost. You will always pay more for the longer term call than you receive for the call you are selling. In the XIU example, the difference is $1.10. For margin purposes, the call you bought effectively covers the sale of the short option. From a risk perspective, the most you can lose from a calendar spread is the net debit (in this example, $1.10).

In some ways the calendar spread is like a covered call, with the longer dated option being a surrogate for shares of the underlying stock. But what really makes the calendar spread appealing is the certainly of time value erosion. The closer the option gets to expiration, the faster time value erodes, eventually falling to zero, if at expiration, the short option is out-of-the-money.

The value of the March 2012 options which expire in 8 weeks will erode at a much faster rate than the March 2013 options expiring in 14 weeks. That is a mathematical certainty. In fact, the short options time value will erode about three times faster than the longer dated option assuming the underlying stock remains in a relatively narrow trading range.

If XIU is at or below $18 at the March 2012 expiration, this position will almost certainly be profitable. Why? Because at the March 2012 expiration, the March 2013 options will still have 12 months to expiry and assuming XIU at $18, would be worth about US $1.50. The net cost for the spread was $1.00 and you are now long March 2013 calls worth $1.50.

But time value erosion is not the only thing that makes of this trade interesting. A low volatility environment enhances this trade because changes in volatility have a bigger dollar value impact on the longer term option. If volatility should rise and the underlying stock still remains in a relatively narrow range, this trade would generate a profit.

For example, the prices used in the XIU example assumed a 15.35% implied volatility. But suppose we applied a 25% implied volatility assumption to the options when the position was established (i.e. with XIU at $17.77 per share). At a 25% volatility assumption, the March 2012 call premiums would be 60 cents versus $1.85 for March (2013) 18 calls. In this case, the difference would be $1.25 instead of $1.10.

There are risks of course. If the underlying stock should rise or fall significantly, the calendar spread will lose money. That’s because time takes a back seat to the relationship between the strike price and the underlying stock price. In short, should the stock advance sharply (assuming we are using calls to create the calendar spread), the short term option will rise at a faster rate than the longer term option.

That mathematical quirk is what makes the calendar spread different from a covered call strategy. With a covered call strategy volatility has no impact on the value of the underlying security.

Ideally when using calendar spreads, you want the underlying stock to remain in a trading range, until the near month option expires. The XIU calendar spread should be profitable if the price of the stock remains between US $17.25 and $18.35 until the March 2012 expiration. Above or below that range, the position will experience a slight loss, assuming volatility remains unchanged. But again, the potential loss is limited to the net debit paid.

Generally, you would not likely lose the entire net debit. As long as the March 2013 option had time remaining it should have some time value. Even if the underlying stock were to drop sharply, volatility would spike, which would benefit the longer term call.

Options Education Days are back. The first 2012 OED will be in Toronto next March 3rd.

Places are going fast! To register, or for information on the program, click here.

We allude to fertilizer, of course, something that hasn’t been much in the news lately, given all the fuss and bother about European (and other) debt problems overhanging the global financial system. But people must eat, and animals must be fed.

It just so happens that supplies of one staple grain crop are tight at the moment. Corn prices rallied by 12.5% in less than a month on fears of dry weather in South America, primarily Argentina and Brazil. But these prices have eased in recent days, as have prices for other products like wheat and soybeans. But these price declines could be seen as buying opportunities by big importers like China, who could raise their quotas.

That bodes well for agricultural supply companies like Canada’s Potash Corp. of Saskatchewan Inc. (TSX: POT, recent price: $45.80) and Agrium Inc. (TSX: AGU, recent price $79.13), both of which are major suppliers of potash, a key element of fertilizer. Shares of both companies have recently traded below historical valuations. And any sign of revival in agricultural products demand could give share prices a shot of Miracle-Gro.

The challenge is the overwhelming number of global uncertainties that can cause traders to transition from risk on to risk off trades. Such short term moves in the market make it difficult to buy for anything more than a short term move on the underlying stocks.

Another complicating factor is that premiums on agricultural stocks tend to be at the upper end of all premiums in the Canadian market. Which for me, makes option writing strategies the favored way to play this trade. From a bullish perspective the two option writing strategies that you could look at are covered call writing or naked put writing. Depending on which side of the fence you are sitting.

If you own the shares or are looking to trade the position inside registered accounts then covered call writing is the only option… i.e. buying the underlying stock and writing a covered call against the shares. In the case of POT, consider buying the shares and writing the April 48 calls at 2.30. The four- month return if exercised is 10.3% and the return if unchanged is 5.3%.

Same storey with AGU, where you would buy the shares and write the April 84 calls. The four-month return if exercised is 9.98% while the return if unchanged is 3.6%.

The naked put story follow the same logic, only you are committing to buy the shares at the strike price of the short put. With POT, for example, write the POT April 46 puts at $3.45. If you buy the shares your net cost is $42.55. If the stock is above $46 per share at the April expiration the put will expire worthless.

With AGU, write the April 80 put for $5.25. If the put is assigned, your net cost to buy the share is $74.75. If the stock is above $80 at the April expiration the put will expire worthless.

Earlier this week, a closely watched indicator suggested continuing improvement in the US economy. The Institute for Supply Management’s manufacturing purchasing managers index climbed to 53.9 in December, up from 52.7 in November. The gauge posted its best reading since June, as factory activity showed broad-based growth across a wide range of industries from car manufacturers to coal producers.

Investors were further heartened by improvements in more detailed metrics included in the ISM report, which showed increases in both new orders (the highest since last April) and hiring (which tracked the broader Labor Department payrolls report).

The Canadian economy, by contrast, added fewer jobs than expected in December. Some 17,500 new jobs were created, a marked change from the large net job losses posted in October and November. Still, consensus estimates had called for about 20,000 new jobs. And the unemployment rate edged up to 7.5% from November 7.4% rate.

With GDP growth only flat in October, the tepid jobs report raises suspicions that the pace of Canada’s economic growth has slowed somewhat. Yet despite that, Canadian manufacturing improved in December as both the RBC Canadian Purchasing Managers Index and the Ivey Purchasing Managers Index posted higher readings for December. The RBC index in fact reached an eight-month high, climbing to 54 in December from 53.3 in November, while the Ivey index rose to 63.5 from 59.9 in November.

Despite the provisos and caveats, the factory sectors in both the US and Canada continue to grow. The trend has had a salutary effect on a sector of the stock market that’s been largely ignored lately – industrials. These are the outfits that make, build, and haul stuff around. Over the past year or so, they’ve had a bad rap, on soft earnings and general investor aversion to cyclic issues that depend on economic growth for performance. Well, that might all be changing as North American economic growth is rekindled.

That could present an opportunity for nimble options traders looking to leverage the upside on industrial stocks that haven’t already started climbing. Bullish positions on beaten down Canadian industrials like Bombardier Inc. (TSX: BBD.B, Friday’s close; $4.16) and Finning International Inc. (TSX: FTT, $23.75) could present bold opportunities for aggressive option traders.

With BBD.B look at buying the July 4.50 calls at 40 cents or with FTT, consider a long position with the June 24 calls at $1.85.

On behalf of everyone at optionmatters.ca, it gives me great pleasure to wish you and your family all the best for this holiday season, and for the new year to come. The blog will be on vacation next week, back on January 4, 2012. Till then, spend time with your loved ones and drive safely!

Year-to-date, the traditional non-cyclical sectors have performed on cue and in textbook fashion, outperforming cyclical stocks by a wide margin. The S&P/TSX Capped Healthcare (+12.8%), Capped Telecom (+13%), Income Trust (+15.4%) and Capped REIT (+13.8%) Indexes have posted year-to-date double-digit gains compared with year-to-date double-digit losses for most every other sector in the TSX.

The most beaten-down subindexes year-to-date are Capped Metals & Mining (-31.2%), Global Mining (-26.4%), Capped Materials (-23%), and Capped Energy (-21.9%).

How much longer can this go on? If you believe the eurozone crisis will continue to influence global economic activity for the next two quarters – and there’s no reason to believe it won’t – then commodity prices may continue to drift downwards for awhile yet. China, one of the world’s largest gobblers of raw materials. But it is contending with a slowdown in growth as its main European export market shrinks. And coming full circle, because a large chunk of Canada’s raw material ends up in China, reduced demand for raw materials implies a direct hit on Canada’s vast resources sector.

China is desperately trying to avoid a “hard landing” for its economy (which most analysts define as growth below the 7% threshold). If that happens in the next quarter or two, Canada’s already beaten-down resources companies are likely to get beaten down even more.

If you believe that things might get worse before they get better, look at bearish sector bets on iShares Capped Energy Index Fund (TSX: XEG, Friday’s close $16.26) and iShares Capped Materials Index Fund (TSX: XMA, $19.25). Specifically buy the XEG March 16 puts at 90 cents or the XMA Mach 19 puts at $1.20.

Conversely, traders looking to protect gains in non-cyclical sectors might consider selling covered calls to hedge against sudden downdrafts in iShares REIT Index Fund (TSX: XRE, $15.23). Specifically sell the XRE March 16 calls at 30 cents or better.

Last week’s billion-dollar plus sale of the Ontario Teachers Pension Plan’s majority interest in Maple Leaf Sports & Entertainment to a couple of Canada’s largest telcos is an example of effective decision-point resolution.

It remains to be seen whether Canada’s Competition Bureau will approve the transaction. But that is secondary. What matters now is investor perception, which so far at least seems to be positive. While shares of both Rogers Communications Inc. (TSX: RCI.B, Friday’s close $36.76) and BCE Inc. (TSX: BCE, Friday’s close $40.74) lost ground in early Friday trading – shortly after the deal was announced – but bounced back by day’s end.

At present Maple Leaf Sports and Entertainment (MLSE) owns three (Maple Leafs, Raptors and Toronto FC) of the five professional sports teams in the Toronto market. Not to mention the Roger’s alliance with the NFL’s Buffalo Bills and the possibility of that franchise ultimately coming to Toronto. And I would not be surprised to see the Blue Jays eventually being rolled into MLSE within the next couple of years. Pity the Toronto Argonauts, as the only “professional” sports franchise left out in the cold.

The likely cause of the initial sell-off in the shares of BCE and Rogers was the acquisition cost. With a purchase price that translates into 17 times current earnings this venture will not be immediately accretive to the bottom line of either company.

There were some US private equity funds sniffing around, but when your financing costs are around 6% annually, none could make a deal work at a price the Teachers Pension Plan wanted. It works for the BCE / Rogers “unholy alliance” because they can finance this with their own capital, or through the capital markets at rates substantially below the 6% threshold. The point being that no matter the cost of financing, MLSE will likely have a slightly negative impact on the earnings of both companies.

That said, MLSE is a profitable marketing and development company that owns the only game in town – i.e. Leafs and Raptors - in Canada’s largest and most concentrated sports market. Any return to the telco’s bottom line will require MLSE to generate additional revenue from higher ticket sales, playoff appearances by the major franchises, or a territorial fee from an NHL expansion team that may well come to the Greater Toronto Area sometime in the next three to five years.

For now, this transaction is all about content for the high profile sports only brands that both BCE and Rogers own. As such, the early negative sentiment driven by earnings expectations may have been an over reaction. As the dust settles, there may be opportunities for option traders.

If you think about the pieces of this pie you have to focus on the biggest slice which is the Toronto Maple Leafs. If the Maple Leafs were to make the playoffs that would provide an earnings boost. But not likely enough to enhance shareholder value for those who own the telco giants. On the other hand, the excitement that such a story would generate could provide momentum to the share price of both companies. But that would be a sentiment induced spike which rarely has long term traction. And of course one has to ask what are the odds that the Maple Leafs make the playoffs anytime in the near future? More to the point the deal does not close until the summer, so any benefit from a Maple Leaf run to the cup will have little impact on 2012 earnings.

Given that view, an option trade should be designed to enhance cash flow – i.e. covered call writing. Only the most aggressive traders who believe that this purchase enhances the growth prospects for both companies would buy calls, and for those traders, focus on long term calls.

With that in mind, the covered call trade would require you to buy BCE and write the May 42 calls at 75 cents per share. With Rogers, buy the shares and write April 38 calls at $1.20 per share.

For the more aggressive trader – who may be dreaming of a Maple Leafs playoff run??? – look at buying the BCE January (2013) 40 calls at $2.25 per share or the Rogers July 38 calls at $1.80.

One of the sectors usually associated with non-cyclical stocks is real estate. You can see that in the sectors performance. The S&P/TSX Capped Real Estate Index was ahead 2.6% year-to-date to the end of November. It is up 6.3% over the past 12 months.

That’s not too surprising, given that the bulk of the index comprises Real Estate Investment Trusts. Dig dipper and the S&P/TSX Capped REIT index, consisting only of REITs, was ahead 13.3% year to date for November and 13.6% for the 12 months ended Nov. 30.

But that enthusiasm hasn’t spread to all members of the family. Brookfield Asset Management Inc. (TSX: BAM.A, recent price $27.93), the real estate, power, and infrastructure conglomerate is actually down 15.9% year to date. Makes you wonder? Brookfield is one of the world’s finest asset managers. It is financially solid and carries less leverage than banks. Not to mention a number of different revenue streams from around the globe, giving it unparalleled currency hedging capability.

Right now, Brookfield is doing what it does best – adding to assets at fire sale prices. Which may account for the company’s short term under performance? It recently assumed ownership of three upscale resorts in the Bahamas as a lead creditor of property developer Kerzner International Holdings Ltd. Kerzner is undergoing a restructuring.

In a US $2.5 billion deal, it recently took US mall developer General Growth Properties out of bankruptcy. Brookfield now holds 40% of the company. Brookfield also reached a tentative deal to take over the collapsed Stuyvesant Town apartment complex in Manhattan… one of the biggest real estate busts of the last two years.

Clearly, Brookfield, taking advantage of its deep pockets, is on the hunt for bargain properties, and is reportedly actively evaluating real estate deals in Europe that have collapsed during the eurozone crisis.

Shares of Brookfield have become deeply oversold during the market turmoil this year. Even a partial resolution of the eurozone crisis, combined with continuing growth in North America, is likely to put the afterburners on Brookfield stock. Aggressive options traders might consider taking bullish positions in Brookfield Asset Management now.

Specifically look at the BAM July 28 calls at $2.30. This is an aggressive trade in which you should only use capital you can afford to lose. There is some significant upside potential, but from a cash management perspective, consider selling half your position if the calls rally to $4.60 or better.

When momentum rules the day in stock markets, it’s difficult to go against the grain. Only the boldest of the bold have the stomach to do so, placing bearish trades in the near-certain expectation of some success. In the past few weeks, that type of speculation has borne fruit. Others rely on defensive strategies to at least hedge their positions somewhat, using options as pure insurance or as a way to generate income until negative sentiment plays itself out.

Currently, the eurozone debt crisis is preoccupying investors who are discounting all manner of catastrophe in the financial system should the eurozone crack up completely. It might happen. Or it might drag out for another year to two. The essential problem is that no one knows, and forecasting is rendered all but impossible given the volatile political dynamics of the eurozone area.

So aggressive traders can either continue to bet on the downside or attempt to generate income from a defensive sector that, while not immune to market crosswinds, has held up reasonably well. The sector in question being; utilities.

Year-to-date the utilities sector is down only 2.2% as measured by the S&P/TSX Capped Utilities Index, compared with the near 15% decline in the overall S&P/TSX Composite Index. Unfortunately, for option traders, there are no optionable utilities indexes in Canada. The alternative is to look at option strategies on individual stocks such as covered writes on individual utilities like Transalta Corp. (TSX: TA, Friday’s close $21.43), Emera Inc. (TSX: EMA, $31.22), and Northland Power Inc. (TSX: NPI, $16.72).

The challenge with each of these names is also what makes them comfortable holdings. Fact is they are not particularly volatile stocks and as such do not command very high premiums. There is also the liquidity issue, which is why call buying does not make much sense. With these stocks, if you can sell the calls you will likely be holding the position until maturity. But then again, this sector is not the worst place to be in an uncertain world.

With TA you could look at writing the Mar 22 calls at 40 cents. In the case of EMA look at writing the March 32 calls at $1.00 or better and finally NRI, sell the April 17 calls at 80 cents or better. The assumption is that you own or willing to buy the shares to cover the short option position.

Download Richard’s presentation at the Options Education Day in Ottawa on November 19th.