Follow Up on Royal Bank

On February 28th, 2013 we wrote a blog discussing if Royal Bank was worth investing in. To read the blog, click here: http://optionmatters.ca/blog/2013/03/01/royal-opportunity/

Our focus was to find an interesting way for investors to play Royal Bank.

At that time in February, these were the facts:

• Royal Bank was trading at $64.12 (02/28/13)
• Royal Bank is paying a $0.60 dividend on April 23rd
• The stock was trading $10.00 lower just 3 months earlier (certainly not a buy low opportunity).

However, at the same time if an investor did not buy that day, the markets could have continued to advance over the next few months, leaving timid investors on the sidelines.

For the stock investor, it has to be a black and white decision to buy. An investor utilizing options can apply a simple strategy as an alternative to buying the stock outright. In that February blog, we looked at the idea of using a traditional call option as a method of entering the Royal Bank Position.

Back then we wanted to control 1,000 Royal Bank shares, but wanted to use the call option as our entry strategy. In that example we bought the April $64.00 call for $1.25. The option expires April 19th, which is 4 days prior to its next x-dividend date.

What was our game plan?

If Royal Bank stock continued higher and was trading anywhere above $64.00 come options expiration, we would exercise our right to buy the shares at $64.00 and own the shares prior to the April 23rd dividend.

By having the call options locking in the upside potential, we had 6 weeks to try to accumulate the stock at much more attractive prices. If at any point over the 6 weeks the market gave us the opportunity to buy Royal Bank shares at a discount to its current price, we would take advantage of it.

What did we accomplish? We created a strategy that gave us a second chance at a first entry. Think about it. If we were wrong for wanting to own Royal back in February, the call will expire but we would have had the chance to buy the shares at much better prices. In the same regards, if Royal continues higher, we had fixed a $64.00 entry and would have exercised prior to its April dividend.

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Now let’s look back at what has happened over the last 5 weeks up until today’s trading (9 days prior to expiration).

Over the last 5 weeks, the stock has traded:

• As high as $64.48 (02/28/13)
• As low as $58.82 (04/08/13)

This worked out perfectly for this example. An investor that bought the shares back in February at $64.12 would be down on the shares hoping that the stock comes back. On the other hand, any investor that paid $1.25 for the call option is likely to lose the total premium, but had several weeks of opportunity to buy the stock as much as $5.32 cheaper. The key observation for the dividend investor is that we did not give up a single dividend payment to execute this strategy. What is it that investors should take away from this exercise? That options are not just for speculation, but can be effectively used as an investment tool in attempts to optimize potential outcomes.