Strangling CIBC?

The last 2 months have been nothing short of a roller-coaster ride for Canadian investors. For most of 2013, the resource stocks have been struggling while the bank stocks were a glimpse of hope. That was short lived as February rolled in as a new round of selling started pressuring the darling Canadian banks. We have now seen close to a 10% drop in some of the bank stocks as investors start to pile in on the sell side. A recent article in the Financial Post has suggested that the short interest in the Canadian Banks is at its highest level since the Lehman collapse.
http://business.financialpost.com/2013/04/29/short-interest-in-canadian-banks-at-highest-level-since-lehman-collapse/.

Clearly, the fears associated with the Canadian housing correction have traders betting that the Canadian banks will hit a bump in the road. This is a double-edged sword because when a short trade gets crowded, it can lead to sudden short squeeze moves higher. Equally, if the stock started to break down, the heavy short interest could fuel investor concerns and drive emotional selling. It is clear that a convincing argument can be made for both bull and bear scenarios which leaves investors more confused than ever.

The best part about trading options, investors can build a strategy to profit from volatility rather than direction. For this blog article, we are going to focus on using a Strangle on the shares of CIBC. If you would like to learn more about the Strangle, watch this short video:
http://www.m-x.tv/media/straddles-and-strangles

Considerations for CIBC (TSX:CM):

April 29th Price: $79.19

2013 High: $84.00

2013 Low: $76.81

Next Earnings: May 23rd, 2013

Next Dividend: June 26th, 2013 ($0.94)

Our trade thesis: With a substantial short interest in the stock, it is likely that the May 23rd earnings announcement could be a catalyst to trigger a substantial market move. With us moving into the seasonal “Sell in May and Go Away” period, CIBC is capable of making a material move either higher or lower.

We will open a strangle strategy using two “out-of-the-money” strikes out to June to ensure enough time to get a potential price impact from the earnings.

Stock Price: $79.19

June $80.00 call is $1.15

June $78.00 put is $1.05

The break even on the spreads on expiration is $82.20 on the upside and $75.80 on the downside.

What can be considered here is that volatility is very likely to remain high as we move toward the earnings, which means a trader has the next 3 weeks to “feel out” the direction of the stock while the options retain a good earnings volatility premium. If over the next 3 weeks the trend of the stock becomes more evident, the trader can recover some of the premium from the losing side of the trade to bring the break-even point lower.

The further consideration is that if a new bullish advance was to get underway for CIBC that sees the stock exceed its 52 week highs, traders could exercise the $80.00 call and take ownership of the stock. Subsequently they can hold the underlying stock for further upside and put themselves into a position to receive the $0.94 dividend at the end of June.

This strategy, while expensive from a premium perspective, gives traders a neutral perspective during a time when there is an ever increasing likelihood for future volatility and the ability to enter the stock if a new uptrend was to get underway.