Profiting on a higher share price for Franco-Nevada Corp.

As you can see in the following graph, the price of shares in Franco Nevada Corp. (FNV) appears to have stabilized at around $99, just above the $95 support level, after having fallen almost systematically since November 28 when it peaked at $110.18. This decline pushed the stochastic oscillator, shown at the bottom of the graph, into oversold territory, while the RSI (Relative Strength Index) indicator rose out of its own oversold zone. This situation could signal the start of a rally of unknown strength and length. In the absence of a price objective, it is usually good practice to sell put options in order to benefit from the time decay. Since this strategy has been covered in prior articles, here we will look at buying call options in lieu of the underlying shares.

Daily Chart of FNV

As we know, the purchase of call options, and options in general, is negatively affected by time decay. This is particularly true in the case of at-the-money options, whose strike price is equal to the share price. In fact, among all the options available, it is at-the-money options that have the most time value. So the investor who wants to limit the negative impact of time decay would avoid buying at-the-money call options and concentrate instead on options that contain the least time value possible. This group includes out-of-the money call options, whose strike price is higher than the share price, and in-the-money options, whose strike price is lower than the share price. We can begin by excluding out-of-the-money options: since we have neither a price objective nor a time interval in mind, they represent too great a risk of losing the entire premium paid. All that remains is in-the-money options. The more that an option is in the money, the less time value it has, and the more that price changes in the option will be correlated with price changes in the underlying share. This is precisely what we need. We want to profit from an increase in the share price while incurring the least possible negative impact of time decay. We are therefore looking for a compromise position between these two constraints.

 
For example, consider the following call options available when FNV is trading at $98.87 on December 20, 2017:

Given the three call options shown above, it is option 3 (FNV 180420 C 80) that has the least time value ($1.13). Its delta of 0.91 (which can be obtained using the Montreal Exchange’s options calculator at https://m-x.ca/marc_options_calc_en.php) tells us that the price of this option is 91% correlated with the price of FNV. It is option 1 (FNV 180420 C 92) that has the most time value ($3.18), and with a delta of 0.72, its price is 72% correlated with the price of FNV. The time value of this option represents close to 50% of its premium, whereas the time value of option 3 represents less than 10%. Lastly, option 2 (FNV 180420 C 86) has a time value of $1.78 and is 84% correlated with the price of FNV. Moreover, the time value represents approximately 15% of its premium.

 
Given the fact that we do not have a price objective in mind nor a specific time interval, we should choose between options 2 and 3, or from among the options available between these two (but not discussed here). Consequently, our choice of one of these two options will be a compromise between the amount of time value, the option’s correlation with the price of FNV, and the price paid for the call option.

Intervention
Since we have no particular target price in mind, the decision on whether or not to sell the position and realize a profit will be based on any new information received from the market between now and April 20, 2018. However, if the price falls, we can immediately say that the support level of $95 should represent a stop level that, if broken through, should trigger the decision to sell the position at a loss.

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.