Investment thesis: TransCanada Corp. (TSX:TRP, NYSE:TRP) has been on a tear over the past few months, gaining almost 50% since its December 2015 low and outperforming main rival Enbridge by a considerable margin. Some investor excitement around the stock was generated by the all-cash $13 billion takeover of Columbia Pipelines at a 32% premium over the then-prevailing market price. Management believes that the transaction, which became effective on July 1st, will be accretive to TransCanada profits. However, the net benefits will not be reflected in earnings any time soon. TransCanada is a top-quality operation, but we feel that the valuation is full right now: the stock’s 12-month forward EV/EBITDA ratio of 14 is a premium to the North American pipeline majors and above our fair value estimate.

Option Strategy: Buy to open a protective put option with a strike price of C$58 expiring on October 21, 2016 at or below C$125 per option (C$1.25 x 100). This trade is recommended for shareholders of TransCanada who wish to protect their holdings against downside risk, but it can also be used as a speculative trading strategy by investors who don’t own TransCanada shares. [The most similar U.S. call option on TRP is the US$45 strike expiring on November 18, 2016.]

Outcomes: If used as a protective strategy by TransCanada shareholders, the option will limit the downside of holding TransCanada shares. On a fully immunized basis, the breakeven price (after accounting for the option premium) is C$56.75, while the maximum loss at expiration is 4.5%.

If used for speculation, the option price will rise considerably if the underlying shares fall – for example, the option would rise 140% if TransCanada’s share price drops to C$55 on expiration day.