Strap on Your Mining Helmets — It’s Time to Dig for Profits

by John Kmiecik | August 30, 2012 8:10 am

Strap on Your Mining Helmets — It’s Time to Dig for Profits

What can you say about a company that has fallen from more than $50 a share to less than $10 — in less than a year? Well, one thing you can definitely say is that it can fall even lower … or it has room to move higher again.

This trade idea is betting on rare-earth producer Molycorp (NYSE:MCP[1]) moving higher now and for several months more and it will allow traders and investors to profit from that move if it happens.

Molycorp (MCP — 12.23): Diagonal Spread

The trade: Buy the January 12 calls and simultaneously sell the September 14 calls for a net debit of $2.10 or better.

The strategy: This strategy is somewhat similar to a covered call. The major difference is that instead of buying the stock, a long-term in-the-money call is purchased, then a slightly out-of-the-money call is sold against the long call in every month. The goal is for the stock to trend slowly up and eventually help pay for the long-term call with the short-term calls’ premium received. The maximum loss for this trade idea is what was paid for the spread.

The rationale: Molycorp is a U.S. based rare-earth miner, but a large percentage of rare earths come from China. Rare-earth materials are used for satellite communications, wave radar amplifiers and other defense communication applications. The company has been waiting for completion of Project Phoenix which would mine in Mountain Pass, Calif. The good news is that the wait is over, and the company hopes to eventually be mining about 40,000 metric tons a year. Now that this project is off the ground, the company should be able to lower its expenses, including energy expenses. The one major problem MCP is left with is generally low rare-earth prices. If demand increases, this problem can be rectified as well.

From a technical perspective, the stock has taken a beating over the last year. But after setting an all-time low last week, the stock has moved up more than 20% this week. If the stock can hold the $12 resistance area like it is trying to do, it might have a decent shot at making to the 14 strike by September expiration. The 14 strike was chosen because the stock set a pivot (significant) low of $14.35 back on Aug. 1. This area might act as resistance for the stock and keep it in check for a time.

The prospects for the stock moving higher look good, and that is why the diagonal spread might be beneficial for this outlook. The best-case scenario is for the stock to rise up to the short strike price every month at expiration. The short call would expire worthless and the long call’s premium would increase.

Consider buying back the short call if the option goes in-the-money. Roll month after month and try to avoid assignment every month, and all along continue to pay down the premium of the long call.

As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities.

Endnotes:
  1. MCP: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCP

Source URL: http://investorplace.com/2012/08/strap-on-your-mining-helmets-its-time-to-dig-for-profits/
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