Bullish Outlook
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Add (ONEX)tra upside without putting on extra downside

Christopher Thom
April 5, 2017
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Add (ONEX)tra upside without putting on extra downside

Onex is a stock that has done very well over the long term. Since going public in 1996, the stock has had an annualized total return over 16%. The company places emphasis on managers owning stock and investing alongside shareholders – this is something I like to look for when investing in a company. For an investor who owns the stock they have 1x leverage to the upside and to the downside. If they want to increase that leverage to 2x on the upside (to a limit) but maintain that same 1x leverage on the downside they can place a trade called a “Levered Overwrite” or a “1×2 Call Spread.” What this consists of is buying a call option and selling two higher strike calls against it to pay for it. This structure provides double the exposure on the upside between the call you are long and the one you are short (between the strike prices of $100-$105) but doesn’t add additional downside.

At the time of writing, ONEX is trading at $96 CAD and is up 5% YTD. If I have 100 shares, I want to buy one September $100 call option for $2.65 which doubles my exposure to the upside above $100. To pay for it, I want to sell 2 September $105 call options for $1.25 each or $2.50 total. In total, I will have to spend $0.15/share to put this structure on. Selling the higher strike calls will cap the return on the 100 shares owned and the call option purchased at the $105 level. It also means there will be 2-1 leverage in that $100-105 window (see table below). At expiry, if shares are trading above $105, there will be a net sell price of $110 which is 14.5% higher than the current share price. The YTD return for me would be 20.4%, which is above Onex’s long-term annual return. Even if the stock rallies well above $110, the maximum value is capped at $110. If the share price does not finish above $100, all of the options will expire worthless and I will be out the $0.15 and can look to try again. If the share price declines from where it is currently, the options will still expire worthless and the value of my stock position will decline, exactly as it would have without doing the levered overwrite, and I would again be out $0.15/share.

If this is a structure that is suitable to your investment objectives and tolerance for risk, there are a few key points to consider. Firstly, this trade cannot be executed in a registered account. You are not allowed to sell uncovered calls in a registered account. In the trade outlined above, one of the calls is covered (the one sold against the 100 shares) but the other is considered uncovered. Secondly, this will only reach the $110 value at expiry. Because there will be more time value in the $105 calls than the $100 calls and no time value in the stock, you will have to wait until the bitter end for the structure to reach its full potential. Finally, is regarding order entry and transaction costs. You will want to make sure that you put these orders in as a spread order so the calls being bought and sold are done at the same time and achieve the desired debit of $0.15. It is important to ensure you are not caught off-guard if assigned; it is likely advisable to close out the option positions on or just before expiration to avoid assignment.

Happy Trading!

Chris Thom

The information contained herein is for general information purposes only and is not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. Many factors unknown to Christopher Thom may affect the applicability of any matter discussed herein to your particular circumstances. You should consult directly with your financial advisor before acting on any matter discussed herein. Individual situations may vary.

Christopher Thom
Christopher Thom https://www.odlumbrown.com/cthom/

Portfolio Manager

Odlum Brown Limited

Christopher’s investment philosophy is based on the principles of value investing. Following an investment style consistent with that of Odlum Brown’s Research Department, he focuses on good companies with solid balance sheets trading below their fundamental valuations. As a Portfolio Manager, Christopher works with clients to build portfolios based on their individual needs. A large part of his business includes using options. By incorporating various options strategies in client portfolios, Christopher aims to increase investment income, reduce portfolio volatility and hedge against large moves in the market or currency fluctuations. Christopher has completed numerous industry courses and achieved the Canadian Investment Manager (CIM), Derivatives Market Specialist (DMS) and Fellow of the Canadian Securities Institute (FCSI®) designations. In addition, he has made several guest appearances on Business News Network (BNN) segments, such as Business Day and The Close, on the topic of options and equities. Investing in the equity markets often consists of following a buy low, sell high strategy. For suitable investors, the use of options strategies can help investors protect their portfolio from downside risk, align their cash flows, improve returns, and achieve their objectives given their comfort with risk. By incorporating the use of options, Christopher helps his clients achieve their long-term financial goals. Many clients have come to Christopher after trading options on their own for years, looking for professional advice, and he enjoys the relationships he has built with them over the years.

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