As the following graph shows, shares in Royal Bank of Canada (RY) veered into correction territory after peaking at $108.52 on January 22, 2018. At the current price of $97.98, the security is down by over 9.7%. With the RSI (Relative Strength Index) indicator on the rise and the stochastic oscillator (%K) indicating that the stock is oversold, all the conditions are in place for the price of RY to rally, given that we are still bullish on the market’s prospects in the long term. A realistic objective for the stock price would be the high of $104 reached in February.
Daily chart for RY ($97.98 on Monday, April 23, 2018)
An investor interested in profiting from this scenario could buy call options expiring on October 19, 2018, selecting the strike that would produce the best return if the stock reaches a price of $104.00 on expiration.
We will choose from among the following call options:
- RY 181019 C 94 at $5.88
- RY 181019 C 96 at $4.63
- RY 181019 C 98 at $3.50
Comparative Table of Call Options
As the above table shows, of these three call options, it is RY 181019 C 96 at $4.63 that has the optimal combination of risk and return, offering a potential return of 72.97% if RY reaches the target price of $104.00 on October 19, 2018. We therefore execute the following transaction:
- Purchase of 10 call options RY 181019 C 96 at $4.63
- $4,630 debit
Profit and loss profile
Target price on the call options RY 181019 C 96 = $8.00 ($104.00 – $96.00)
Potential profit = $3.38 per share, for a total of $3,380
Potential loss = $4.63 per share, or $4,630
Even though the target price for shares of RY is $104.00, our potential profit is tied to the target price of $8.00 on the call options. Consequently, as soon as the price of the options reaches $8.00, we will liquidate the position, even if RY has not yet reached the target price of $104.00.
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.