Buying Put Options to Hedge Shares
As the following graph shows, shares in Waste Connections Inc. (WCN) have been rallying since February 6, 2018, when they bottomed out at $81.52. As I write these lines, WCN is priced at $96.67, up 18.58%. The RSI indicator and stochastic oscillator are now in extreme overbought territory. Even though this is not, in itself, an indication that the stock’s run is over, some caution may be advised at this point. An investor who managed to buy shares in WCN at around $85, when it was in extreme oversold territory, could now buy protective puts in order to continue profiting from this price surge and still be protected over the next few weeks from a potential drop.
Daily chart as at March 15, 2018 ($96.67)
As the above chart shows, $92 represented a resistance level and it should now serve as a support level. We are ready to let the stock fluctuate normally above this level, but a significant break through our support level could be a sign that the trend has turned in the opposite direction. As a result, we will buy puts with a strike price of $92 expiring on May 18, 2018. Remember that our selection of a strike reflects our preferred level of protection. When buying puts, the higher the strike, the more expensive the protection.
Position
- Holding 1,000 shares in WCN at $85
- Debit of $85,000
- Profit at the current price of $96.67 = $11,670
- Purchase of 10 put options WCN 180518 P 92 at $1.10
- Debit of $1,100
Profit and loss diagram
Our purchase of the puts WCN 180518 P 92 at $1.10 gives us the right to sell 1,000 shares of WCN at $92 each, between now and May 18, 2018. This means that we are protected against any drop below this level, from now until the expiration of the puts. In a down-market scenario, we would still be able to hold on to our $5,900 profit. The strength of this position lies in the fact that we can still profit from a continued surge in the price of WCN.
Intervention
With a position like this, it is better to see where the market goes for a while, and then re-evaluate the situation at about half way to the expiration of the puts. This would be around April 20, 2018. Then we could make a decision based on new data, and decide whether we still want to hold on to the stock.
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.
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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