by John Kmiecik | November 4, 2013 8:49 am
There’s no doubt the markets are going through some uncertainty right now. Many analysts are saying that stocks are extended and need to pull back, yet others think there’s more room to move higher. This trade idea on Potash (POT) is similar to the market, but in this instance, it can profit either way.
The trade: Buy the POT Jan 32 call and the Jan 31 put for $2.55 or less.
The strategy: A strangle is when a call and a put are generally bought one strike out-of-the-money with the same expiration. Strangles are volatility spreads; when a strangle is bought, it is done in the expectation of a big move either up or down. In effect, an option trader has an opinion about volatility … just not the price. The maximum profit on a strangle is theoretically unlimited because the stock can continue to rise forever and pretty much fall to zero.
Breakevens in the case of Potash stock are at $34.55 and $28.45 at expiration based on a cost of $2.55. The maximum loss is $2.55 or whatever was paid for the strangle if POT finishes between $31 and $32 at January expiration. Both options would expire worthless.
The rationale: Potash, like many fertilizer companies, was not expected to do well this earnings season. Potash earnings were announced just more than a week ago, and lo and behold, it did not disappoint those who thought it would disappoint. POT reported a roughly 30% drop in Q3 revenues, but the really staggering part about that number was that about two-thirds of the drop was due to falling potash sales. Nitrogen sales also fell almost 20%, and falling crop prices have also contributed to the demise because of the influence they have on fertilizer prices.
Where does the industry — and more specifically, Potash stock — go from here?
It’s hard to say because there are so many influences on the industry both here in the U.S. and overseas. And that’s exactly why a strangle might make the most sense.
Click to Enlarge The current implied volatility of POT January options are currently less than historical levels, making them relatively cheap to buy. This trade idea can profit if Potash stock moves with some conviction either higher or lower. Since this trade idea is long a call and put, either one can take advantage if the situation.
Looking at the activity of POT shares over the last year, it is evident that Potash stock has been volatile in the past. This, of course, doesn’t necessarily mean it will again be volatile, but there certainly is a chance.
Considering the uncertainty in the general market, the debt ceiling crisis still hanging on and Potash’s volatile nature, this might be a terrific opportunity to watch your profits grow!
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities. Get a free trial of John’s live options trading room here.
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