TD Bank Long Term Call Management

Back on January 30th, I posted a blog outlining a strategy to limit your risk for a longer term bullish position on TD Bank. For full details please reference What About The Banks? I suggested that with TD shares trading at $51.00, we could purchase call options at the $52.50 strike price expiring in January 2016 for $2.99 per contract.

On February 13th, TSE:TD shares closed at $55.50 and the January 2016, $52.50 calls closed at $5.20 which represents a 73% return on your risk…had you locked in your profits at that point.

In all fairness, I was looking at this as a longer term proposition. The intention was to stay exposed to the potential upside of TD Bank shares, while limiting the capital outlay and risk exposure. As a way to reduce the cost basis further, I suggested that in an unregistered account, we could sell near term calls against the longer term position. I looked at writing the February $54 calls and collecting $0.20. Since TSE:TD shares closed at $53.96 on the February expiration Friday, the $0.20 credit would be realized and the average cost of the position would be reduced to $2.79.

Now, following that approach, on Monday, February 23rd, The March $56 calls were bidding $0.26. Notice that with shares advancing in our favour, we have rolled the written contract strike up to $56. It now gives us the potential for an extra $2.00 appreciation in the shares before having to consider making any adjustments or closing the position. Our average cost basis at this point would be $2.53.

Since then, the shares have pulled back and currently trade at $53.20. There are now a few technical signs that indicate that we may see a continuation lower. For the novice technician, the easiest to identify is the break below the 200 day moving average as pictured below:

So we now have 2 choices:

1. Close the position:

The current value of the January 2016, 52.50 strike call is bidding $3.15. We could close the position profitably, however we can’t forget about the March $56 calls we wrote. They have to be bought back. The current ask for this contract is $0.05. We will basically be giving 5 cents of our 26 cent credit back. This brings the average cost of the January 2016 $52.50 calls to approximately $2.58. By closing this out today and moving to the sidelines, we would lock in 22%.

2.Buy a short term put:

If your intention is to hold the position for the duration, you can purchase a 1 month put option to hedge out any significant decline and possibly profit from a short term sell off. The April 52 strike put is asking $1.00. By purchasing this short term protection, we would be basically creating a calendar strangle. We are long the January 2016 $52.50 calls and long the April 2015 $52 puts. Considering the credit collected from the short term calls writes, the addition of the protective put increases our average cost to $3.53. If our expectation that the shares will reach $58.00 by January 2016 remains in tact, this still offers the potential for a 56% return on our risk. It is important to note that this will vary depending upon our option writing approach over the following months and whether the stock trades above our written strike in any given month. If the shares drop to $50.00 by the April expiration of the $52 puts, the put contracts will have an intrinsic value of $2.00. With the original cost being $1.00, the additional $1.00 profit now further offsets the cost of your long term call.

Regardless of which approach to managing this trade we choose, we have a number of solutions at our disposal to make adjustments. By using options as a replacement strategy to owning the TSE:TD shares, we have had a limited risk exposure from the start. In addition, as the market conditions change and our outlook on a position is questioned we can be proactive with locking in profits or modifying our risk exposure.