Quarterly Newsletter - January 2017

THE OPTIONS PLAYBOOK

Covered Call onFranco-Nevada (FNV)

Cash Covered Put onRogers Communications (RCI.B)

p.7

MANAGER’SCOMMENTARY

p.3

CANADIAN EQUITYDERIVATIVES

2

2017 Trading Calendar

Patrick CeresnaPatrick Ceresna is the Chief Derivative Market Strategist for Learn To Trade Global (LTTG) and optionsource.net and has been a content provider and speaker for the Montreal Exchange for over 5 years. Patrick is a Chartered Market Technician (CMT), Derivative Market Specialist (DMS) and Canadian Investment Manager (CIM) by designation. Prior to becoming a partner at LTTG, Patrick spent ten years working at key financial firms in numerous trading roles including the trading of a large fund dedicated exclusively to options writing. Patrick specializes in analyzing the intermarket relationships of the broader derivatives market and the impact those trends have on trading and investment decision making.

GENERAL INFORMATION

For more information, please contactJosiane Lanoue, Senior Manager, Business Development, Equity Derivatives jlanoue@m-x.ca or 514 871-3539

Expiration

Last trading day

Listing

Equity & ETFs options

Weekly options

Options on the US Dollar (USX)

J A N U A R Y F E B R U A R Y M A R C H

S M T W T F SM T W T F S S M T W T FS S

S&P/TSX 60 Index Options (SXO)

8 9 10 11 12 13 14

1 2 3 4 5 6 7

22 23 24 25 26 27 28

29 30 31

12 13 14 15 16 17 18

5 6 7 8 9 10 11

1 2 3 4

19 20 21 22 23 24 25

12 13 14 15 16 17 18

5 6 7 8 9 10 11

1 2 3 4

19 20 21 22 23 24 25

26 27 28 29 30 3126 27 28

15 16 17 18 19 20 21

By Patrick Ceresna

3

The Trump administration has made it very clear that protectionism is a top priority. Many Canadians are quick to suggest that the focus will predominantly be on China and Mexico, but that may be an erroneous assumption. The incumbent administration has made it clear that the retaliatory trade measures against Mexico apply to Canada as well. This “America First” agenda is great for Americans, but presents many uncertainties for Canadians. This comes at a time when the Canadian economic growth is floundering, searching for where the fuel for the next growth cycle will come from. At least for now, it is fair to say that it is too early for investors to panic on trade policies that have yet to be created and bilateral negotiations that have yet to be had.

So where are the real risks in the first quarter of 2017?

Interest rates. The bond markets peaked in the summer of 2016 and were broadly distributing in the months prior to the election, but it was the animal spirits associated with a Trump/Republican victory that ushered in a sharp drop in bonds and general rise in interest rates. Why is this important? Because it was not just a rise in interest rates in the U.S., but a broad rise in global risk premiums in almost all global bond markets. This is where the real collateral damage of the trump administration lies.

In Canada, we have modest inflation and slow growth. The Bank of Canada Governor Stephen S. Poloz has been reluctant to raise short-term interest rates in Canada as many analysts are suggesting there is no immediate catalyst to raise rates. Yet, interest rates on the 10-year Government of Canada bond, which was yielding 0.954% on September 29, 2016, has almost doubled, hitting 1.837% on December 15, 2016. That is not a central bank driven rise in rates, rather it was predominantly driven by a rise in global risk premiums. It certainly doesn’t help that predominant rock star bond managers have been openly contemplating the end of a secular bull market in bonds.

THE MANAGER’S COMMENTARY

3

44

THE MANAGER’S COMMENTARY

Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

1.600

1.400

1.200

1.000

12/15 1.837

1.837%

0.954%

Source: www.bloomberg.com/quote/GCAN10YR:IND

This is, unequivocally, the single biggest macro issue for the first half of 2017.

The implications may be far reaching. Here is how Bank of Canada views the risk:

“A large and persistent rise in global risk premiums and the ensuing increase in interest rates

would lead to tighter financial conditions, a drop in confidence, weaker growth and rising debt-

service burdens, both globally and in Canada. Since the 2007–09 global financial crisis, Canada’s

external assets and liabilities have both grown rapidly. On the liability side, this rise is mostly

attributable to the purchase of Canadian debt securities by foreign buyers. There is a risk that

these foreign portfolio investment inflows—which have put downward pressure on borrowing

costs for Canadians—could reverse and thus exacerbate the increase in risk premiums. This re-

pricing of risk would prove to be even costlier if fixed-income market liquidity turns out to be

fragile.”

Source: www.bankofcanada.ca/2016/12/fsr-december-2016/ pg. 15

Government of Canada 10-year Note

55

THE MANAGER’S COMMENTARY

5

The tension on broader interest rates are likely to continue to pressure Canadian mortgage rates higher at a time when house prices are historically high and affordability in question. Will the rising level of Canadian household indebtedness and the rising mortgage rates usher in the much talked about housing slowdown?

There is a second risk to a Trump administration that must be accounted for – China.

The Bank of Canada has been for years publishing their list of risks to the stability of the Canadian financial system and persistently they have highlighted the risk of stress emanating from China and other emerging-market economies.

The changes highlighted here are fundamentally altering trading in fixed-income markets. Although the market has been able to withstand some recent shocks, it is difficult to ascertain how well this evolving market struc-ture will withstand unpredictable and longer-lasting shocks.

Key RisksThis section examines risk scenarios for the Canadian financial system in which trigger events (or shocks) are transmitted and amplified by vulner-abilities, resulting in adverse effects on the financial system and the economy. The purpose is to identify the most important risks rather than all possible negative scenarios. The FSR focuses on downside risks, which are usually low-probability events that have the potential for a significant negative impact on the financial system and the economy should they occur. Each risk includes an overall risk rating based on Governing Council’s judgment regarding the probability of the risk occurring and the expected severity of the impact on the Canadian financial system if it were to materialize (Table 3). The risks are unchanged from the June 2016 FSR, except for the rating for Risk 4, which has decreased from moderate to low.

Risk 1: Household Financial Stress and a Sharp Correction in House PricesIn Risk 1, a large and persistent rise in unemployment across the country is assumed to create financial stress for many highly indebted households, resulting in a significant cutback in consumption spending and a correction in house prices. The decline in house prices is likely to be more pronounced in areas that have experienced strong run-ups, such as the GVA and the GTA. The resulting defaults on loans and declines in collateral values exert

Table 3: Key risks to the stability of the Canadian fi nancial system

Risk 1: Household fi nancial stress and a sharp correction in house prices

Risk 2: A sharp increase in long-term interest rates driven by higher global risk premiums

Risk 3: Stress emanating from China and other emerging-market economies

Risk 4: Prolonged weakness in commodity prices

Impact: Less severe More severe

Probability:Higher

Risk 3

Lower

Risk 4 Risk 2 Risk 1

Low Moderate Elevated High Very high

14 ASSeSSment oF VulneRAbilitieS And RiSkS BANK OF CANADA • FINANCIAL SySTEM REVIEW • DECEMBER 2016

Source: www.bankofcanada.ca/2016/12/fsr-december-2016/ pg. 14

Does the Trump administration make this an immediate and present danger?

China continues to have material imbalances in its currency flows as they are trying to contain a 1 trillion-dollar+ capital outflow over the last 18 months. They have been very aggressive with capital controls and have been trying to turn the tide without having to raise interest rates domestically. This has been forcing the Chinese to sell their U.S. Treasury holdings and adding further pressure to interest rates in the U.S. and abroad.

6

I ask the question, will 2017 start with a Trump euphoria hangover? Canadians will have no tax cuts and no new fiscal stimulus as the Liberals have already been implementing their political promises over the past year. What if the numbers continue to be lackluster? What if Trump was to insist to renegotiate Canada’s trade agreements? One way or another, it is easy to be able to conclude that 2017 will be volatile and that the Canadian markets can easily regress back to their long-term mean levels.

Considering Using Options?

For those professionals that are not utilizing options as an active part of their portfolios, one may consider that today’s market environment is strategically ideal. Option strategies can help create compelling ways for managers to keep participating to the long side of an overbought market with a defined risk. In addition, options can further be used to enhance your income returns and be used to hedge the downside risks of stocks and ETFs.

Learn more by accessing all the free guides and strategies at www.m-x.ca/educ_guides_strat_en.php

China’s credit and currency issues are incredibly complex. Many analysts continue to forecast that the Peoples Bank of China will be able to successfully orchestrate a soft landing and recovery, but will a pending trade war with America be the imbalance to usher in a more ominous economic cycle?

What is most bizarre is that Canadian Consumer Confidence has been on the rise as we are approaching 6 year highs. This is counter intuitive to the rising levels of household debt and mortgage rates, but could be rationalized by animal spirits as many Canadians have been captivated by the political drama south of the border. How long will this confidence continue?

74

76

78

80

82

84

86

75.3

Jan 2012 Jul 2012 Jan 2013 Jul 2013 Jan 2014

79 79 79 79.7

81.2

84.4

77.6

Canadian Consumer Confidence

Source: www.tradingeconomics.com | Decima Research Inc.

6

THE OPTIONS PLAYBOOK

Covered Call on Franco-Nevada (FNV)

Franco-Nevada Corporation remains one of the premier gold-focused royalty and streaming companies. Even during the most challenging phases of the three year gold bear market, the company has been able to persevere, always remaining profitable beyond a few quarters. Over the last six months, Franco-Nevada’s share prices have been consolidating in correlation with gold mining companies. We view this as an opportunity to buy the stock and generate income with a covered call.

Here is the breakdown:

• Franco-Nevada (TSX:FNV) is trading at $83.70 (January 16th, 2017)

• FNV had a 52 week range of $58.67 - $105.69

• The July 21st, 2017 $88.00 call is bidding $6.00

One can generate a 7.17% premium income for selling the 6-month covered call while leaving $4.30 upside on the stock.

• If the stock declines, investors average cost base (break-even) would be $77.70 ($83.70-$6.00)

• If the stock remains range bound, investors can generate a healthy income while owning a solid gold royalty company

• Alternatively, if the stock was to rise above $88.00 and investors were assigned on the covered call, they would have made a $10.30 (12.31%) return in a half year.

7

THE OPTIONS PLAYBOOK

Cash Covered Put on Rogers Communications (RCI.B)

Rogers Communications remains one of Canada’s telecom juggernauts. Recently, the entire telecom space

has pulled back. Driven by the anticipation of higher interest rates, there has been a general rotation out of

low-beta defensive names and into the high-beta cyclical sectors. If the economic data in the upcoming

months proves to be benign, there is an opportunity to accumulate these beaten down defensive names at

potentially favorable levels. One way to accumulate stocks is to sell put options at levels you are willing to

own the shares. Let’s look at an example using Rogers.

Here is the breakdown:

• Rogers Communication (TSX:RCI.B) is trading a $51.12 (January 16th, 2017)

• RCI.B had a 52 week range of $46.15 - $58.99

• The July 21st, 2017 $50.00 put is bidding $2.20

• Every put sold represents an obligation to potentially have to buy 100 shares or $5,000.00 ($50.00 x 100)

by the expiration

The $2.20 premium represents a 4.40% income in just 6 months for undertaking the obligation.

• If the stock declines below $50.00, investors will be assigned to the shares with an adjusted cost base (break-even) of $47.80 ($50.00-$2.20) or $3.32 lower then where it is currently trading and relatively close to its 52 week low.

• If the stock remains range bound or bullish, investors generated a respectable income return.

8

9

FOR ITS 10-YEAR ANNIVERSARY,THE MONTRÉAL EXCHANGE BLOGGETS A NEW LOOK!

› New look › New contributors › New tips to profit from the use of options!

A Montréal Exchange initiative

optionmatters.ca

10

Top 10 Most Active Option Classes (Q4 2016)

Options Trading Volume by Sector Q4 2016

Most Crossed Option Classes

RANK SYMBOL VOLUME INSTITUTIONAL RETAIL INSTITUTIONAL % RETAIL %1 XIU 2,669,746 2,487,777 181,969 93% 7%

2 RY 255,335 98,037 157,298 38% 62%

3 ZSP 242,125 240,295 1,830 99% 1%

4 MFC 231,756 147,236 84,520 64% 36%

5 XGD 205,824 149,636 56,188 73% 27%

6 TD 203,656 73,327 130,329 36% 64%

7 ECA 203,635 114,433 89,202 56% 44%

8 BMO 193,500 94,182 99,318 49% 51%

9 BNS 186,773 87,227 99,546 47% 53%

10 CM 177,247 80,688 96,559 46% 54%

RANK SYMBOL CROSS VOLUME

1 XIU 2,487,777

2 ZSP 240,295

3 ZEB 166,930

4 XGD 149,636

5 MFC 147,236

6 ECA 114,433

7 RY 98,037

8 BMO 94,182

9 ZCN 90,815

10 BNS 87,227

11 XEG 84,970

12 CM 80,688

13 L 78,694

14 ENB 75,500

15 TD 73,327

16 TX60 71,265

17 NA 68,299

18 BCE 67,703

19 XFN 61,729

20 SU 60,076

Source: Bloomberg Note: Options volume from delisted or acquired companies are excluded.

MARKET STATISTICS

28%Financials

27%Energy

21%Materials

4% Consumer Discretionary

3% TelecommunicationServices

4% Consumer Staples

5%Industrials

4% Utilities2% InformationTechnology

1% HealthCare

1% RealEstate

500,000

750,000

1,000,000

1,250,000

1,500,000

1,750,000

2,000,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

2,250,00090,000

Average Daily Volume Open Interest

2012 2013 2014 2015 2016YTD

July Aug. Sept. Oct. Nov. Dec.Jan. Feb. Mar. Apr. May. Jun.

Average Daily Volume Open Interest

60,000

70,000

80,000

90,000

100,000

110,000

120,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

2012 2013 2014 2015 2016YTD

July Aug. Sept. Oct. Nov. Dec.Jan. Feb. Mar. Apr. May Jun.

11

Equity Average Daily Volume and Open Interest

ETF Average Daily Volume and Open Interest

MARKET STATISTICS

OVER A 5 YEAR PERIOD

OVER A 5 YEAR PERIOD

OVER A 12 MONTH PERIOD (2016)

OVER A 12 MONTH PERIOD (2016)

© 2017 Bourse de Montréal Inc.

This document is sent to you on a general information basis only. The information provided in this document, including financial and economic data, quotes and any analysis or interpretation thereof, is provided solely on an information basis and shall not be interpreted in any jurisdiction as an advice or a recommendation with respect to the purchase or sale of any derivative instrument, underlying security or any other financial instrument or as a legal, accounting, tax, financial or investment advice. Bourse de Montréal Inc. recommends that you consult your own advisors in accordance with your needs. All references in this document to specifications, rules and obligations concerning a product are subject to the Rules and Policies of Bourse de Montréal Inc. and its clearinghouse, the Canadian Derivatives Clearing Corporation. Although care has been taken in the preparation of this document, Bourse de Montréal Inc. and/or its affiliates take no responsibility for errors or omissions and reserve the right to amend or review, at any time and without prior notice, the content of this document. Bourse de Montréal Inc., its affiliates, directors, officers, employees and agents will not be liable for damages, losses or costs incurred as a result of the use of any information appearing in this document.

Standard & Poor’s and S&P are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and have been licensed for use by S&P Dow Jones Indices LLC and sublicensed for certain purposes by Bourse de Montréal Inc. TSX is a registered trademark of TSX Inc., and has been licensed for use by S&P Dow Jones Indices LLC and Bourse de Montréal Inc. The S&P/TSX 60 Index is a product of S&P Dow Jones Indices LLC, and has been licensed for use by Bourse de Montréal Inc. The products mentioned in this document are not sponsored, endorsed, sold or promoted by S&P Dow Jones Indices LLC, Dow Jones, S&P, their respective affiliates, or TSX Inc. and neither S&P Dow Jones Indices LLC, Dow Jones, S&P, their respective affiliates or TSX Inc., make any representation regarding the advisability of investing in such product(s).

“BAX®”, “OBX®”, “ONX®”, “OIS-MX™”, “CGZ®”, “CGF®”, “CGB®”, “LGB®”, “OGB®”, “SXO™”, “SXF™”, “SXM™”, “SCF™”, “SXA™”, “SXB™”, “SXH™”, and “SXY™” are trademarks of Bourse de Montréal Inc.

Montréal Exchange, Montréal Exchange logo, Converge, and Converge logo are trademarks of Bourse de Montréal Inc.

OptionMatters.ca

m-x.ca/rssm-x.ca/linkedinm-x.ca/facebook

m-x.ca/twitterm-x.tv

Trading Tools

Useful Links

GUIDES MX INDICES OTHERS

» Equity derivatives

» Index derivatives

» Currency derivatives

» Equity options tax regime

» S&P/TSX 60 VIX Index (VIXC)

» MX Covered Straddle Writers’ Index (MPCX)

» MX Covered Call Writers’ Index (MCWX)

» Options List

» Put/Call Ratios