Commitment to Buy Stock Through a Ratio Spread
As you can see in the following chart, the price of shares in Canopy Growth Corporation (WEED) appears to be stabilizing, for now, in a range between a high of $74.45 reached on September 5, 2018 and its most recent low of $52.80, reached on September 14. We can also see that its high of $48.72 on June 22 may represent a support level if the stock falls, so we have a support zone of $52.80 to $48.72. An investor who sees growth potential in the stock and who is not afraid to buy the stock if its price falls could implement a strategy that includes a commitment to buy shares if the price drops. This requires implementing a put ratio spread strategy.
Daily chart as at September 21, 2018 ($64.46)
A put ratio spread involves purchasing a put option and writing two put options with a lower strike. It is therefore a bear spread strategy, with another put contract added on the side. The objective in writing the two options is to collect an amount that is greater than what was spent purchasing the other option. If the stock goes up, we are sure to make a profit. This profit will vary, depending on the difference between the stock’s price and the strike of the strategy’s options. If the stock falls, the strategy is still profitable down to the strategy’s break-even point, which is the cost to the investor of buying the shares.
Position
- Put ratio spread
- Purchase of 10 put options, WEED 181005 P 64 at $4.60
- Debit of $4,600
- Sale of 20 put options, WEED 181005 P 60 at $2.75
- Credit of $5,500
- Net credit of $900
Profit and Loss Profile of the Ratio Spread on WEED at Expiration on October 5, 2018
This put ratio spread involves purchasing 10 put options, WEED 181005 P 64 at $4.60, and writing 20 put options, WEED 181005 P 60 at $2.75, for a total credit of $900. The credit represents the maximum profit if WEED holds steady and closes at a price equal to or greater than the $64 strike when the options expire on October 5. This strategy will turn a profit as long as WEED stays above the breakeven point of $55.10, and it has a maximum potential profit of $4,900 if the stock closes at exactly $60, the options’ strike, on October 5. If it closes below this strike, the investor will have to buy 1,000 shares of WEED at $60/share, but in fact their net cost will be $55.10. This represents a 14.50% margin of protection, given the stock’s current price of $64.46. An investor who is not interested in purchasing the stock if the share price drops will need to take defensive measures if it falls considerably below the $55.10 break-even point.
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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