Options Brief-Week of August 28
Everyone looks forward to something for different reasons. When investors choose to invest in a company, they will wait impatiently for the most crucial announcement: earnings season. Last week, Royal Bank of Canada (TSX:RY) reported a strong third quarter which led to a dividend hike of 5 per cent to 91 cents per share. This dividend increase came as a surprise for investors mainly due to the current state of the Canadian housing sector. However, the low unemployment rate and the recent rate hike by the Bank of Canada appear to have rekindled investors faith in the financial sector. Last Friday, August 25th, RY was trading at $93.25, up $1.00 from the previous week.
Prior to the earnings release, bullish investors could have positioned themselves to profit from this unexpected outcome. Below is a table comparing a stock purchase with buying call options to profit from an increase in the underlying stock. In order to benefit from a rise in the stock, an investor can purchase 1,000 shares of RY or as an alternative, purchase 10 $92.00 September 2017 call options. Remember that each call option controls 100 shares.
Both strategies will have benefited from the increase in the stock, but the use of options comes with a few added benefits. Even though from an absolute return perspective, the stockholder would make a greater profit than the options buyer, he would also have a much greater risk exposure ($92,250 vs $1,590). Moreover, given the options ability to provide leverage, the long call position will generate a more attractive return percentage (10.69% vs 1.08%). Note that investors will also be left with extra uninvested capital to pursue other investment opportunities, which has the potential to add extra diversification to their portfolio. For investors having a bearish outlook, the purchase of put options could have positioned them accordingly.
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