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How to turn a profit with puts following a technical rejection

Martin Noël
October 11, 2018
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How to turn a profit with puts following a technical rejection

How to turn a profit with puts following a technical rejection

As the following chart shows, the price of shares in Linamar Corporation (LNR) surged to a resistance level of $65 after a free trade agreement was reached with the U.S., and it has since been on a steady decline. This response, which does not bode well, could bring the stock back down as far as a support zone of $47 to $52, with a realistic objective of $50, representing a drop of 12%.

 

Daily Chart for LNR ($56.88 on Tuesday, October 9, 2018)

 

An investor who agrees with this scenario and wants to profit from it could buy put options expiring on January 18, 2019, selecting the strike that would yield the best return if the stock is trading at $50.00 when the options expire.

We will choose from among the following put options:

  • LNR 190118 P 54 at $2.55
  • LNR 190118 P 56 at $3.35
  • LNR 190118 P 58 at $4.35
  • LNR 190118 P 60 at $5.55

 

Position

Comparative Table of Put Options

 

As you can see in the above table, of the four put options, the one with the best risk-return ratio is LNR 190118 P 58, at $4.35. It has a potential return of 83.91% if LNR hits the target price of $50.00 on January 18, 2019. So we will execute the following transaction:

 

  • Purchase of 10 put options, LNR 190118 P 58, at $4.35
    • $4,350 debit

 

Profit and Loss Profile

Target price on the put options, LNR 190118 P 58 at $4.35 = $8.00 ($58.00 – $50.00)

Potential profit = $3.65 per share ($8.00 – $4.35), for a total of $3,650

Potential loss = $4.35 per share (the premium paid) or $4,350

 

Intervention

Even though the target price for shares of LNR is $50.00, our potential profit is tied to the $8.00 target price on the put options. Therefore, as soon as the price of the puts reaches $8.00, we will liquidate the position, even if LNR has not yet reached the target price of $50.00.

 

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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2 Comments

  1. Roland Montmartre

    What on earth is a “technical rejection” ?????

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