Writing put options based on a 50-day moving average

As the following graph shows, the stock of Colliers International Group (CIGI) has begun a slight correction following a strong bullish trend that began in February, and it has now landed right on its 50-day moving average. Its RSI and the stochastic oscillator are trending upwards, so the bullish trend will be confirmed if the stock rises above its 20-day moving average.

Daily chart as at August 17, 2018 ($104.58)

In the meanwhile, the stock may tread water. In this case, writing put options may be a good strategy for profiting from either a rally in the stock or from its relative stability. Should prices begin to trend downward, the investor will need to be prepared to purchase the shares at the selected strike price.

Position

• Write 10 put options, CIGI 180921 P 105, at $2.85
  • Credit of $2,850

Profit and Loss Profile

Writing ten put options, CIGI 180921 P 115 at $2.85, pays out $2,850 ($2.85 x 10 contracts x 100 shares per contract). As the above table shows, this put option is currently $0.42 per share in-the-money ($105 strike – current price of $104.58) and contains $2.43 of time value ($3.85 – $0.42). This premium of $2.85 per share provides protection against a drop of up to 2.3%, i.e. to the breakeven price of $102.15 ($105 strike – $2.85 premium). The strategy’s maximum profit is the total credit received ($2,850), and it will be realized if CIGI closes at a price equal to or greater than the $105 strike when the options expire on September 21, 2018. This profit represents a 2.8% return over 35 days, or 29.1% on an annualized basis. The static profit, meaning the profit generated if the stock treads water, is $2.43 per share, for a total of $2,430 for the 10 contracts. The static return is 2.4% for the 35-day period, or 24.8% on an annualized basis. If CIGI is still trading at below the $105 strike when the options expire, the investor will be obliged to buy 1,000 shares of CIGI at $105, at a net cost of $102.15 per share ($105 strike – $2.85 premium). Any decline below this level will represent a loss on the strategy.

Intervention

There are three ways to manage this position. First, the investor who is not afraid to buy the shares if the price drops can just hold the position without intervening. Then if the stock is trading at below $105 when the options expire, the shares will be assigned and the investor will buy them. Second, the investor can intervene if the price falls sharply below the breakeven price, buying back the options written in order to cut his losses. Third, if the share price jumps, the investor can intervene by buying back the options written for between 10% and 20% of the initial premium (in this case, for $0.40 to $0.80). Under the second and third scenarios, more put options can be written at that time, if appropriate.

Good luck with 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 an option strategy.