Looking in the Rear View Mirror

Richard Croft
June 11, 2011
6 minutes read

Occasionally I assess the impact of various strategies presented in MX’s Blog. It’s not about gloating when successful or finding fault when I am wide of the mark. But rather, it is about learning from past successes and failures to become better traders in the future.

Some of the ideas posted in May…

May 1, 2011 – High Tech Play

In this blog, I talked about the problems facing Research In Motion (TSX: RIM, Friday’s close $35.82). In short, the RIM story is all about a company losing market share in a growth industry.

At the time RIM was trading at $46.09 and I suggested two possible strategies; 1) buying RIM June 46 puts at $2.75 and 2) using a RIM short May 46 / long May 52 bear call spread. The spread would have netted the trader a $1.50 credit.

The long June 46 put strategy is still in play. At the end of trading on Friday, the June 46 puts were bid at $10.20. If you did the initial trade and have yet to take profits, now is the time. The May bear call spread expired out-of-the-money on May 21st. With that strategy you would have retained the $1.50 net credit received.

May 8, 2011 – Seismic Shifts and Contrarian Thinking

This blog was a contrarian call on Teck Resources Limited (TSX: TCK.B, Friday’s close $45.51). There were a number of bullish traders in the market at the time of the trade, and I was talking about potential slowdowns in emerging markets which would have a negative impact on TCK. At the time TCK was trading at $48.80.

As with RIM, I suggested a long put strategy (buy the TCK June 48 puts at $2.35) and a bear call spread (short TCK June 50 calls, long TCK June 56 calls at a net credit of $1.40). The long put was the more aggressive strategy, while the bear call spread had less potential, but with a net credit and limited risk, provided an alternative to laying out capital.

The limited risk element set out in both trades is key. Where possible, traders should always set up an option trade where the risk is clearly defined. The most you can lose with the long put strategy is the cost of the put. The most you can lose with the bear call spread is the difference in strike prices less the net credit received.

That point was brought home quickly, as TCK rallied the week immediate following the blog. Timing is everything! TCK topped out at the end of May around $51 per share, which meant that both trades were underwater. However, if you were able to maintain the positions because of the pre-set risk limits, you are now able to reap some profits.

The TCK June 48 puts were bid at $2.95 as of the close of trading on Friday. The TCK bear call spread could be closed out for 12 cents (offered price on the June 50 calls at the close of Friday).

May 15, 2011 – Consumer Theme

On May 15th, I looked at another contrarian trade around the consumer staples sector. My premise was to look for defensive positions because I believed that the market would enter a transition phase during the summer. The so-called “trade t’il May and go away” theme.

I suggested that traders look at buying George Weston Ltd (TSX: WN, $69.99) June 72 calls at 85 cents, when the stock was at $71.03. The stock rallied above $73 per share by the end of May, and then fell back as global markets sold off.

There was an opportunity to exit the position with a profit, as the June 72 calls were trading at $1.50 per share near the end of May. Typically, with a low volatility stock, you want to take some money off the table if you see the options rally by 50% or more.

As of Friday’s close the WN June 72 calls had a bid of 3 cents per share, which for our rear view model, means that the position has lost 100%.

May 24, 2011 – The Protection Game

This was my first blog highlighting the urgency of the European debt woes and the general slowdown in global growth. The macro view that was highlighted in the column was as follows;

“In light of contagion fears, we are likely see a period of heightened market volatility. In all global markets… including Canada! And without the prospect of further easing by the US Federal Reserve (i.e. QE III which we may yet see), there will be a period of slow growth, and more likely, a market correction.”

I suggested that traders look to buy some insurance, and with XIU trading at $19.63, highlighted the purchase of XIU Sept 19.50 puts at 70 cents. The closing bid on Friday for the XIU Sept 19.50 puts was 97 cents. Since this is an insurance policy and has more than three months to expiry, I would consider holding the position and perhaps selling half if you can get $1.20 to $1.40 for the puts.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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