Options Action on Bombardier

From time to time I like to take a look at the “Most Active Options” ranking on the Montreal Exchange home page. It was no surprise to see that 6 out of the 10 were mining companies this morning. Since Richard Croft already posted and interesting article on this sector the other day entitled Gold, Where’s the Glitter, I decided to take a look at a few of the other stocks.

Bomardier (TSX:BBD.B) trading at $3.90 caught my attention, and upon review of the chart it appears to be a potential bullish opportunity.

Bomardier (TSX:BBD.B) WEEKLY CHART

With that in mind, I took a look at the option chain to determine just where all of the action was taking place. Today, there was some unusual activity on the April $4.00 strike puts. As I have outlined in previous blogs, it is difficult to determine just what the rationale is behind the increased volume. Knowing if it was an opening transaction, closing transaction, a buy or a sell would help us determine the objectives of the trader.

Since we can’t make that determination, I am going make an assumption that this was an In-The-Money Put Write. The put option is determined to be In-The-Money since the stock is currently below the strike of the put option contract. With the stock currently trading at $3.90, the $4.00 strike, April Put would have an intrinsic value of $0.10. The bid on this option is $0.19.

The question is, why would anyone sell an In-The-Money put? Remember that the put option writer is paid a premium to take on an obligation to buy the shares at the strike price selected. This obligation is only valid if the shares are trading below the strike price and it’s enforceable until the close of the market on the third Friday of the expiration month selected.

In this case, if the investor was looking to generate cash flow, but was ultimately ok with owning the shares at $4.00 if assigned, the put option write would satisfy this objective. If the Bombardier shares are trading above $4.00 at expiration, the investor keeps the premium. This would represent an approximate 1.8% return for the time period or an annualized rate of return of almost 20%.

If the shares remain below the $4.00 strike, the investor would be assigned to take ownership of the shares at $4.00. The premium collected from the put write is the investors to keep. This lowers the average cost base down to $3.81. Once the shares are in the investors account, the Covered Call strategy may be implemented to further enhance returns, in addition a modest 2.6% dividend will be collected.

The risk is if the shares have significantly dropped in value. While the average cost base and subsequent break even point have been reduced, the investor can experience unidentifiable losses as the share price drops below their break even point.

Some Considerations

• The Put Write has the same risk/reward profile as the Covered Call
• The investor must have sufficient enough capital to meet margin requirements
• The Put Write strategy is not permissible in RRSP and TFSA accounts