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Put-Writing Strategies in the Canadian Market

Patrick Ceresna
April 13, 2020
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Put-Writing Strategies in the Canadian Market

The coronavirus crisis has caused massive sell-offs in global equity markets throughout the world.  Canada has not been immune, and our benchmark large-cap S&P TSX 60 Index has lost over 36% from its February high.

 

CHART 1 – S&P/TSX60

Source: Bloomberg

 

A move of this magnitude from new highs to a bear market is unprecedented in history. Due to the large amount of uncertainty being fueled by the coronavirus, option traders are bidding up the implied volatility levels of many stock and equity index products.

For example, the implied volatility of the XIU ETF (iShares S&P/TSX 60 ETF) has spiked to its highest level in five years (data courtesy of Bloomberg):

 

CHART 2 – S&P/TSX60 Implied Volatility

Source: Bloomberg

 

For an investor with a long-term investment horizon, this offers an attractive entry point for put-selling strategies.

Investors who engage in such strategies should understand the risks associated with shorting puts.  However, as long as they are willing to own the securities at the price in which they could be put, the high level of implied volatility offers an attractive risk-reward opportunity to the more sophisticated investor who can take advantage of the uncertainty generated by the coronavirus crisis.

For example, on March 30, 2020, the XIU September 18, 2020 PUT could be sold for $1.00 per contract.

 

Table 1: Breakdown of the Trade

Source: Big Picture Trading

 

The $16 strike represents a level that is more than 40% below the February high.  At that price, an investor who feels confident that the XIU ETF represents good value should consider shorting the puts.

By shorting the September 18, 2020 $16 PUT, the investor is assuming an obligation to buy XIU at $16 for the next two quarters, but will be paid an amount of 6.25% of the underlying ($1 divided by $16) for providing that service.

The payoff profile for the position at expiration is as follows:

 

Table 2: Potential Outcomes on Expiry

Source: Big Picture Trading

 

As long as XIU closes above $15.00 (the breakeven price), the position will be profitable.

This trade is definitely designed for more sophisticated investors, but for those who understand the risks, the current environment is ideal for put-writing strategies.

 

Disclaimer:

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.

Patrick Ceresna
Patrick Ceresna http://www.bigpicturetrading.com

Derivatives Market Specialist

Big Picture Trading Inc.

Patrick Ceresna is the founder and Chief Derivative Market Strategist at Big Picture Trading. Patrick is a Chartered Market Technician, Derivative Market Specialist and Canadian Investment Manager by designation. In addition to his role at Big Picture Trading, Patrick is an instructor on derivatives for the TMX Montreal Exchange, educating investors and investment professionals across Canada about the many valuable uses of options in their investment portfolios. Patrick is also co-host to the MacroVoices weekly podcasts. Patrick specializes in analyzing the global macro market conditions and translating them into actionable investment and trading opportunities. With his specialization in technical analysis, he bridges important macro themes with the attempt to understand when those trends are beginning and understanding where they likely to go. With his expertise in options trading, he seeks to create opportunities that leverage returns, while managing/defining risk and or generating consistent enhanced income. Patrick has designed and teaches Big Picture Trading's Technical, Options and Macro Masters Programs while providing the content for the members in regards to daily live market analytic webinars, alert services and model portfolios.

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