The Metals Company (NASDAQ:TMC) stock has popped and then dropped since the company changed names following a merger on Sept. 10.
TMC stock has had quite a range in that time frame with a high of $15.39 and a low of $5.08. It has also joined the cadre of the Reddit meme stocks so expect the volatility to continue.
TMC is a Canadian company focused on seafloor exploration for metals used in battery manufacturing.
The battery industry has certainly been charged up recently given the ever-increasing adoption of electric vehicles. This has led to a dramatic increase in investor interest in this space.
InvestorPlace contributor William White noted the recent uptick in activity last week in TMC stock following the merger with Sustainable Opportunities Acquisition.
Implied volatility also had a big uptick since the merger as well, exploding from under 200 on Sept. 13 to over 260 on Sept. 27.
This means the price of TMC options rose dramatically during that period.
A Closer Look at The Metals Company Stock
TMC stock fell sharply in that same period, dropping from $12.45 to today’s price of about $5.20.
The combination of a lower-priced stock with a zero lower bound and higher implied volatility provides an opportunity to take advantage of an option pricing anomaly for TMC stock bulls.
Normally, out-of-the-money option spreads trade at a lower price than in-the-money spreads. This makes intuitive sense since option pricing is based on probability. Out-of-the-money spreads are intrinsically worthless. In-the-money spreads carry intrinsic value.
This follows the same reasoning as individual options. In-the-money options are obviously worth more than out-of-the-money options.
Let’s look at Apple (NASDAQ:AAPL) as an example. The stock closed at $145.37 on Monday.
The October $142/$140 put spread (out-of-the-money) was priced at 40 cents. The October $144/$146 call spread (in-the-money) was priced at $1.15. Apple’s implied volatility is roughly 27.
This makes sense since there is a much greater likelihood that the call spread will be worth something at expiration versus the put spread.
If AAPL stock remains unchanged until Oct. 15 expiration, the call spread would be worth $1.37 while the put spread would be worth zero.
For TMC options, however, the normal relationships have fallen by the wayside due to the enormous implied volatility and low-priced stock.
The combination of extreme implied volatility well over 200 and the nearby zero boundary of a low-priced stock means out-of-the-money put spreads actually can trade at a premium to in the money call spreads.
How to Trade TMC Stock
TMC closed at $5.58 on Monday. The November $5/$2.50 put spread was trading at $1.05 while the November $5/$7.5 call spread was priced at just 75 cents.
This was despite the fact that the November put spread was fully out-of-the-money while the call spread was actually in-the-money.
It sets up ideally for a risk reversal trade using spreads instead of outright options.
You could sell the Nov $5/$2.5 put spread and buy the Nov $5/$7.5 call spread for a 30 cent net credit.
Break-even on the trade is $4.70 or nearly 15% below the $5.58 closing price of TMC stock.
The maximum gain of $2.80 is realized if TMC stock rallies $1.92 (34%) and closes above $7.5 at Nov. 19 expiration.
A maximum loss of $2.20 is realized if TMC stock drops over $3 (another 55%) and closes below $2.50 on Nov 19 expiration.
The margin requirement for the trade is $2.20 for each risk reversal. Standstill return is $0.88, or 40% if TMC remains unchanged at expiration.
On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. Tim makes weekly appearance on TD Ameritrade Morning Trade Live, CBOE TV Vol 411, Business First AM Trader Talk and bi-monthly appearances on Bloomberg TV Options Insight to discuss options and volatility. Tim has also been invited for reoccurring appearances on CNBC’s Volatility Playbook.