Writing Put Options to Profit from Higher Prices for Shares of Premium Brands Holdings Corporation

As the following graph shows, the share price of Premium Brands Holdings Corporation (PBH) has been on a bullish trend, with some more or less large corrections since reaching a plateau in the spring of 2017. Until we see evidence to the contrary, we should assume that this trend will continue for a while.

Daily chart as at January 29, 2018 ($106.50)

A bullish trend like this one does not provide any well-defined target prices for making an optimal selection of call options. Furthermore, since the amplitude is rather limited — the chart clearly shows plateaus lasting several weeks — selling put options appears to be our best strategy, since it will allow us to profit from both rising prices and relative price stability.

Position

• Write 10 put options, PBH 180420 P 105 at $3.50
  • Credit of $3,500
    

Profit and Loss Profile

By writing the 10 put options, PBH 180420 P 105 at $3.50, we collect $3,500 ($3.50 x 10 contracts x 100 shares per contract). As the above table shows, this option is currently out-of-the money and has no intrinsic value. As a result, 100% of the premium is time value. So we are taking advantage of the time decay from now until April 20, 2018, if the price of PBH rises, but also if it is relatively unchanged or even if it falls down to the $105 strike (the static profit). We will realize the strategy’s maximum profit if PBH closes at a price higher than or equal to the $105 strike when the options expire on April 20, 2018. This maximum profit represents a 3.4% return over 80 days (a 15.7% annualized return). The $3.50 premium also gives us a cushion against the stock price declining by as much as 4.5%, meaning that it can fall to the breakeven price of $101.50 (the $105 strike less the $3.50 premium) before the position begins to produce losses.

Intervention

There are three ways to manage this position. The first is for an investor who is not afraid to buy the shares if their price falls. In this case, the position is held without any intervention, and if the stock falls below the strike of $105 upon expiration, the shares are assigned and the investor simply buys them back. The second approach is to intervene if the price falls significantly below the breakeven price, by buying the put options written as a way to cut your losses. The third approach involves intervening if the price of the shares rises significantly, by buying back the put options written for 10% to 20% of their initial premium (in this case, for between $0.35 and $0.70). In the last two cases, other put options can be sold if it is still justified.

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.