As you can see in the chart below, the price of Canadian Pacific Railway Limited (CP) stock is beginning to show the signs of what looks very much like the early stages of a correction. It is clear that the MACD and RSI indicators and the stochastic oscillator are all in marked decline. If this is the case, the price may fall to $200 in the coming weeks.
An investor interested in profiting from this scenario could buy put options expiring on January 18, 2018, choosing a strike that would yield the best return if the price reaches $200 on expiration.
We will choose one of the following four puts:
As you can see in the table above, of the four put options, the at-the-money put (CP 190118 P 215 at $6.13) offers the best risk-reward ratio, with a potential return of 145% if CP hits the target price of $200 on January 18, 2018. Consequently, we will carry out the following transaction:
Target price of put options CP 190118 P 215 = $15
Potential profit = $8.87 per share for a total of $8,870
Potential loss = $6.13 per share or $6,130
Even though the target price for CP stock is $200, our potential profit is tied to the $15 target price on the put options. So we will liquidate the position as soon as the price of the puts reaches $15, even if CP stock is still above $200. Furthermore, to avoid the maximum loss of $6,130, it would be advisable to take a loss by liquidating the put options if the CP stock price reaches new highs.
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.