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Writing covered calls as a hedge against a slight drop in the shares of Sun Life Financial Inc.

Martin Noël
January 9, 2017
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Writing covered calls as a hedge against a slight drop in the shares of Sun Life Financial Inc.

As can be seen in the following weekly chart, shares in Sun Life Financial Inc. (SLF) have broken out of a range of $35 to $45 that has characterized trading since the beginning of 2014. In principle, $45 should now be a support level for SLF trades over the next few months. This sharp jump – we’re looking at an increase of close to 20% above the $45 upper bound in just a few weeks’ time – has allowed SLF to climb as high as $53.75.

slf

Even though this upswing may have lasting power in the medium term, we should expect the price of SLF to fall slightly over the next few weeks, since both the RSI indicator and the stochastic oscillator are over 90. If the past, periods when both these indicators have suggested such extreme overbought conditions have been followed by price drops or by periods of price instability (see the above graph).

 

To take advantage of this scenario, investors could write one call for each 100 shares they own of SLF. With a closing price at $51.99, we will choose calls with a $52 strike in order to take advantage of the option’s eroding time value, which is at its highest for at-the-money options. In order to have a few weeks of flexibility, we will also choose options expiring on January 20, 2017.

 

Position

  • Prior ownership of 1,000 shares of SLF (current price of $51.99)
  • Sale of ten call options, SLF 170120 C 52, at $1.25
    • $1,250 credit

 

Profit and loss profile

pl_slf

 

  • The position’s maximum profit of $1.26 per share or 2.48% (21.58% on an annual basis) will be obtained if SLF closes at a price greater than or equal to the
    $52 strike price upon expiry on January 20, 2017.
  • The static profit (the profit if the stock’s price is unchanged) is $1.25 per share or 2.46% (21.41% on an annual basis).
  • The breakeven price is $50.74, for a level of protection of 2.40%.

 

Further action

 

Since we are expecting the price of SLF to be stable or to drop slightly, we will buy back the calls at a price below or equal to $0.25, if we have the chance. If the price of SLF rises, a decision will need to be made on whether or not to buy back the call options we wrote, at a loss, based on whether or not we want to sell our shares. Over the next few weeks, we will take another look at this position.

 

Good luck in 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 options strategies.

 

Martin Noël
Martin Noël http://lesoptions.com/

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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