The coronavirus crisis has caused massive sell-offs in global equity markets throughout the world. Canada has not been immune, and our benchmark large-cap S&P TSX 60 Index has lost over 36% from its February high.
CHART 1 – S&P/TSX60
A move of this magnitude from new highs to a bear market is unprecedented in history. Due to the large amount of uncertainty being fueled by the coronavirus, option traders are bidding up the implied volatility levels of many stock and equity index products.
For example, the implied volatility of the XIU ETF (iShares S&P/TSX 60 ETF) has spiked to its highest level in five years (data courtesy of Bloomberg):
CHART 2 – S&P/TSX60 Implied Volatility
For an investor with a long-term investment horizon, this offers an attractive entry point for put-selling strategies.
Investors who engage in such strategies should understand the risks associated with shorting puts. However, as long as they are willing to own the securities at the price in which they could be put, the high level of implied volatility offers an attractive risk-reward opportunity to the more sophisticated investor who can take advantage of the uncertainty generated by the coronavirus crisis.
For example, on March 30, 2020, the XIU September 18, 2020 PUT could be sold for $1.00 per contract.
Table 1: Breakdown of the Trade
Source: Big Picture Trading
The $16 strike represents a level that is more than 40% below the February high. At that price, an investor who feels confident that the XIU ETF represents good value should consider shorting the puts.
By shorting the September 18, 2020 $16 PUT, the investor is assuming an obligation to buy XIU at $16 for the next two quarters, but will be paid an amount of 6.25% of the underlying ($1 divided by $16) for providing that service.
The payoff profile for the position at expiration is as follows:
Table 2: Potential Outcomes on Expiry
Source: Big Picture Trading
As long as XIU closes above $15.00 (the breakeven price), the position will be profitable.
This trade is definitely designed for more sophisticated investors, but for those who understand the risks, the current environment is ideal for put-writing strategies.
Originally Posted on April 13, 2020 – Put-Writing Strategies in the Canadian Market
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.
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