Getting Paid With the Intention of Buying Shares

As the following chart shows, the price of shares in Canadian Tire Corporation Limited, Cl. A (CTC.A) plunged 20.6%, from a peak of $183.93 on August 8 to its recent trough at $146.08 on October 11. It has since climbed to just above $150, allowing us to use this trough as a short-term support level. An investor who is confident in the company’s fundamentals, who is not afraid to buy shares below this level, and who believes that the stock still has growth potential in the medium to long term could take advantage of this situation by writing put options with a strike price of $145. These options would oblige the investor to buy 100 shares per put option written, receiving a premium to cover the associated risk in exchange. Collecting this premium is nothing short of getting paid to buy shares if their closing price falls to below the $145 strike price on expiry. In addition, this position allows the investor to take advantage of either a rally in the stock or its relative stability going forward. If the stock closes at a price that is higher than the strike price, the investor will realize the maximum profit on the strategy, which is the premium received. This is a win-win situation.

Daily chart as at October 22, 2018 ($150.73)

Position

• Sales of 10 put options, CTC 181221 P 145, at $3.30
  • Credit of $3,300 

Profit and loss profile

By writing ten puts, CTC 181221 P 145, at $3.30, the investor collects $3,300 ($3.30 x 10 contracts x 100 shares per contract). As shown in the above table, this put option is out-of-the money, so the $3.30 premium consists entirely of time value. The option provides protection against the stock price falling an additional 6% below the $145 strike price, i.e. to the breakeven price of $141.70 (the $145.00 strike – the $3.30 premium). The strategy’s maximum profit is the total credit received, i.e. $3,300, which will be realized if CTC.A closes at a price greater than or equal to the $145 strike price on expiry on December 21, 2018. This profit represents a return of 2.3% over 60 days, or an annualized return of 14.2%. As we can see, the static profit – i.e. the profit generated if the stock price does not change – is equal to the maximum profit. If the price of CTC.A is less than the $145 strike price on expiry of the options, the investor will be obliged to buy 1,000 shares of CTC.A at $145 per share (a $145,000 out-of-pocket expense), at an effective cost of $141.70 per share (the $145.00 strike – the $3.30 premium). A drop in the stock price below this level will mean that the investor incurs a loss.

Intervention

There are three ways to manage this position. The first is for the investor who is not afraid to buy the shares if the price falls. In this case, the position is kept without taking any action, and if the stock is trading at less than the $145 strike on expiry, the investor is assigned and just buys the shares. The second involves taking action if the price falls significantly below the breakeven, buying the puts written in order to limit the losses. The third involves taking action if the price of the shares rises sharply, buying the puts written at a price of 10% to 20% of their initial premium (in this case, for about $0.30 to $0.60). In the last two cases, we can write more puts if the situation still calls for it.

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.