February 28, 2018
3 minutes read
As the following graph shows, the share price of Dollarama Inc. (DOL) fell $22.60, from a high of $170.00 reached on January 29 to a low of $147.40 on February 9, 2018. DOL then rallied to $158.97, right up to the level of its moving averages. Since then, the stock has been below its moving averages, and if it continues to fall, there is a chance that it could reach $136.37 over the next few weeks. That level would represent a decline of $22.60 from its recent high of $158.97.
Daily Chart for DOL ($153.03 on Friday, February 23, 2018)
An investor interested in profiting from this scenario could buy put options expiring on July 20, 2018, selecting a strike that would produce the best return if the stock reaches a price of $136.37 on expiration.
We will choose from among the following puts:
- DOL 180720 P 155 at $11.25
- DOL 180720 P 160 at $14.05
- DOL 180720 P 165 at $17.35
Comparative Table of Put Options
As the above table shows, of these three put options, DOL 180720 P 160 at $14.05 has the optimal combination of risk and return, offering a potential return of 68.19% if DOL reaches the target price of $136.37 on July 20, 2018.
We therefore execute the following transaction:
- Purchase of 10 put option contracts DOL 180720 P 160 at $14.05
Profit and loss profile
Target price on the put options DOL 180720 P 160 = $23.63 ($160.00 – $136.37)
Potential profit = $9.58 per share, for a total of $9,580
Potential loss = $14.05 per share, or $14,050
Even though the target price for DOL shares is $136.37, our potential profit is tied to the target price of $23.63 on the puts. Consequently, as soon as the price of the puts reaches $23.63, we will liquidate the position, even if DOL has not yet reached the target price of $136.37. Furthermore, in order to avoid incurring the maximum loss of $14,050, it would be prudent to take a loss by liquidating the put options if DOL rises above its recent high of $158.97.
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.