Brazilian stocks have been on a tear, with its Bovespa Index up 15% year to date, as equities there have been buoyed by Brazil’s interest-rate cuts, signs of growth in the United States and renewed optimism that Europe may be closer to solving its debt crisis.
One of the Bovespa’s leaders is Vale S.A. (NYSE:VALE), the world’s largest supplier of iron ore. In addition to iron ore, the company also produces and sells manganese, alloys, gold, nickel, copper, kaolin, bauxite, alumina, aluminum and potash. It also operates railroads and maritime terminals in Brazil.
Vale has seen earnings increase by 25% in the past five years, yet it continues to trade at just 5.7 times trailing earnings. Recently the company raised its dividend by $6 billion and now provides a 6.0% yield. Since 2008 Vale has increased its dividend by 208%.
The company is set to release earnings on Feb. 23, and analysts expect earnings to rise to $1.33 per share from the previous quarter’s 93 cents. Here in front of earnings, we want to gain bullish exposure to Vale by “selling to open” the VALE March 26 Puts, which are currently trading with 32.0% implied volatility. This is high compared to the stock’s realized volatility of 28.6%.
With shares trading at $26.50, we see Vale as a great value and believe the March 26 Put is over-valued. And because we’ll be collecting the premium upfront in this trade, the option’s overvalued level means more money in our pockets.
If the company impresses investors with its announcement, we expect to see the stock make a bullish move and implied volatility to collapse in the March options, both of which benefit a short put position.
Should Vale close below $26 at March expiration we will be put the stock at very attractive levels. And since the option premium collected is ours to keep, we have essentially lowered our basis in the stock.
Here’s a quick summary of this trade…
Stock Price: $26.50
Option Play: Short Put
Sell: March 26 Put @ 85 cents
Net Credit: 85 cents
Breakeven: $25.15 = $26 – 85 cents (Short Strike – Net Credit)
Max Profit: 85 cents (Net Credit)
Max Loss: Unlimited