Purchasing put options based on a bearish flag
As the following graph shows, in July 2018, Shopify Inc. cl. A (SHOP) reached a double peak at around $230. This slowed its momentum, with the stock subsequently falling to $172.90 to climb back up to its current level, $195.81, by Friday, August 10, 2018. This rally, which looks very much like a bearish flag, may be short-lived. If this is the case, the trend will turn bearish again, with the stock testing the $140 support level.
Daily Chart for SHOP ($195.81, Friday, August 10, 2018)
An investor who agrees with this scenario and wants to profit from it could buy put options expiring on October 19, 2018, selecting the strike that would yield the best return if the stock is trading at $140.00 when the options expire.
We will choose from among the following put options:
- SHOP 181019 P 150 at $2.60
- SHOP 181019 P 160 at $3.65
- SHOP 181019 P 170 at $5.65
- SHOP 181019 P 180 at $8.40
Position
Comparative Table of Put Options
As the above table shows, given these four put options, it is SHOP 181019 P 160 at $3.65 that has the optimal combination of risk and return, offering a potential return of 447.95% if SHOP reaches the target price of $140.00 on October 19, 2018. So we will execute the following transaction:
- Purchase of 10 put options, SHOP 181019 P 160, at $3.65
- Debit of $3,650
Profit and Loss Profile
Target price on the put options, SHOP 181019 P 160 at $3.65 = $20.00 ($160 – $140)
Potential profit = $16.35 per share ($20.00 – $3.65), for a total of $16,350
Potential loss = $3.65 per share (the premium paid) or $3,650
Intervention
Even though the target price for shares of SHOP is $140.00, our potential profit is tied to the $20.00 target price on the put options. Therefore, as soon as the price of the puts reaches $20.00, we will liquidate the position, even if SHOP has not yet reached the target price of $140.00.
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.
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