Strangling CIBC

The Canadian banks find themselves feeling a substantial hangover as the Canadian stock market continues to lag. The ongoing stories of the risks to the Canadian real estate market awaken fears of a U.S. style correction that would certainly leave question marks about the bank balance sheets.

Debt continues to be a dominant component for maintaining the current standards of living. In a Financial Post article by Greg Quinn and Ilan Kolet, they highlighted that 1 in every 10 families are in debt greater than 250% of gross income. To read the article, visit: http://business.financialpost.com/2013/07/03/canadas-housing-boom-has-pushed-one-in-10-families-deep-in-debt/?__lsa=c0d4-90ba

It is not clear if this will escalate into something severe or if the problems can be diverted. Traders or investors have to place their bets on the stocks and hope to anticipate the outcome. If wrong, investors risk feeling considerable pressure on the position.

Alternatively, traders can consider utilizing an options strategy like the Strangle. If you are unfamiliar with the strategy, watch this short video explaining the strategy: http://www.m-x.tv/media/straddles-and-strangles.

In this example, we propose a strangle strategy on CIBC. Here are some general observations on CIBC shares:

• Current price on July 5^th is $74.30
• Year high was February 20^th $84.00
• Year low was July 3^rd $73.89
• Dividend: $3.84 (5.10%) ($0.96 Sep26, 2013)

The shares of CIBC are now close to $10.00 (12%) off their highs, which is immediately perking up the ears of a number of value investors that consider price dips like this as an opportunity to buy. While we cannot say that is right or wrong, a strangle strategy gives the trader/investor an interesting way to feel out the stock.

Our trade idea would look like this:

Prices as of July 5^th:

• Buy the July $74.50 call for $0.75.
• Buy the July $74.00 put for $0.70.
• Net cost is $1.45 for 2 weeks of time.
• Our downside break-even is $72.55 and upside break-even is $75.95.

This makes sense to us as the stock is in a very volatile period, yet the implied volatility is still relatively reasonable. The shares have seen $3.00-$4.00 swings over the last several weeks and there is little evidence that market conditions have calmed down.

The Plan:

Bear outcome: If the stock continues to plunge lower toward $72.00 or $70.00, the put will serve as a way to modestly profit from the drop, net of the total cost of the trade. Equally if the lottery comes in and we see a dramatic drop, we could happily extract an attractive return.

Bull outcome: The shares are oversold. If CIBC even retraces 50% of the prior drop, we could see the stock trading at $77.50-$78.00 on the upside. This would be a satisfactory profit. But there is an alternative scenario where, if investors feel that the stock has in fact bottomed, the investor can exercise the $74.50 calls and take ownership of the shares.

To us, this neutral position offers the opportunity to let the market prove to the investor which way they should be positioned. Unlike the committed value investors and technical traders, we can remain without bias and let the markets price action shape our future prospective.