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A Bullish Position to Optimize Risk-Reward

Martin Noël
April 25, 2018
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A Bullish Position to Optimize Risk-Reward

As the following graph shows, shares in Royal Bank of Canada (RY) veered into correction territory after peaking at $108.52 on January 22, 2018. At the current price of $97.98, the security is down by over 9.7%. With the RSI (Relative Strength Index) indicator on the rise and the stochastic oscillator (%K) indicating that the stock is oversold, all the conditions are in place for the price of RY to rally, given that we are still bullish on the market’s prospects in the long term. A realistic objective for the stock price would be the high of $104 reached in February.

Daily chart for RY ($97.98 on Monday, April 23, 2018)

An investor interested in profiting from this scenario could buy call options expiring on October 19, 2018, selecting the strike that would produce the best return if the stock reaches a price of $104.00 on expiration.

We will choose from among the following call options:

  • RY 181019 C 94 at $5.88
  • RY 181019 C 96 at $4.63
  • RY 181019 C 98 at $3.50

 

Position

Comparative Table of Call Options

 

As the above table shows, of these three call options, it is RY 181019 C 96 at $4.63 that has the optimal combination of risk and return, offering a potential return of 72.97% if RY reaches the target price of $104.00 on October 19, 2018. We therefore execute the following transaction:

 

  • Purchase of 10 call options RY 181019 C 96 at $4.63
  •                  $4,630 debit

 

Profit and loss profile
Target price on the call options RY 181019 C 96 = $8.00 ($104.00 – $96.00)
Potential profit = $3.38 per share, for a total of $3,380
Potential loss = $4.63 per share, or $4,630

 

Intervention
Even though the target price for shares of RY is $104.00, our potential profit is tied to the target price of $8.00 on the call options. Consequently, as soon as the price of the options reaches $8.00, we will liquidate the position, even if RY has not yet reached the target price of $104.00.

 

Good luck with your trading, and have a good week!

 

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

 

 

Martin Noël
Martin Noël http://lesoptions.com/

President

Monetis Financial Corporation

Martin Noël earned an MBA in Financial Services from UQÀM in 2003. That same year, he was awarded the Fellow of the Institute of Canadian Bankers and a Silver Medal for his remarkable efforts in the Professional Banking Program. Martin began his career in the derivatives field in 1983 as an options market maker for options, on the floor at the Montréal Exchange and for various brokerage firms. He later worked as an options specialist and then went on to become an independent trader. In 1996, Mr. Noël joined the Montréal Exchange as the options market manager, a role that saw him contributing to the development of the Canadian options market. In 2001, he helped found the Montréal Exchange’s Derivatives Institute, where he acted as an educational advisor. Since 2005, Martin has been an instructor at UQÀM, teaching a graduate course on derivatives. Since May 2009, he has dedicated himself full-time to his position as the president of CORPORATION FINANCIÈRE MONÉTIS, a professional trading and financial communications firm. Martin regularly assists with issues related to options at the Montréal Exchange.

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