The recent recovery in gold prices hasn’t been isolated to the commodity itself. Gold mining stocks have also seen an influx of buying, with many breaking above key resistance levels to continue their longer-term uptrends.
One of the miners that looks particularly ripe for the picking is Newmont Mining Corp. (NYSE:NEM). With implied volatility currently nestled in the middle of the six-month range, and trading right in line with historical volatility, option prices seem neither a steal nor overly expensive.
So, how do you play it with options?
First, let’s look at the typical behavior of gold miners. The price action tends to be a bit more erratic, which increases the odds of shorter-term aggressive traders getting whipsawed out of their trades.
The answer in this situation may lie in entering a cheaper spread trade that doesn’t require too much micromanaging – the call butterfly spread.
(If you aren’t able to do butterflies in your account or you’re looking for a simpler strategy, I’ll give you an alternative in just a moment.)
Conventional butterflies are taught as neutral trades, but can be structured with more of a directional tilt by modifying the strike prices involved. The basic structure of a long butterfly is to sell the “body” and buy the “wings.”
The trade has a structure of 1 x 2 x 1. The body of the fly should be centered at whatever your target price is for the stock.
In the case of NEM, let’s say we think the stock is likely to reach $75 by December expiration. So we’re going to center the fly at $75 by selling two NEM Dec 75 Call options.
To complete the position we now need to buy the wings – a call option with a strike below the body and one above the body. Let’s buy the NEM Dec 70 Call and the NEM Dec 80 Call.
To sum things up, we’re “buying to open” one Dec 70 Call (currently trading for $2.70) and one Dec 80 Call (currently trading for 35 cents) – that’s a $3.05 debit so far. Meanwhile, we’re “selling to open” two Dec 75 Calls (currently trading at $1.05 each, or a $2.10 total credit on this part of the trade). The max risk is limited to the initial debit and the max reward is limited to the distance between the strikes minus the initial debit.
Since the NEM fly outlined above is a $5 spread and can be purchased for around 95 cents ($3.05 debit – $2.10 credit), the max risk is limited to $95 and the max reward is $405.
Structured in this manner, we will gain our max profit if NEM is sitting right at $75 at December expiration. If it remains below $70 or rises all the way above $80 by December options expiration we will incur the max loss of $95.
Not ready to break out the butterfly net? An alternative would be buying the NEM Dec 70-75 bull-call spread outright (i.e., buying the $70 Calls for $2.70 and selling the $75s for $1.05, for a $1.65 net debit). The cost is a bit higher and it therefore has more risk than the fly, but I like the call spread better than buying a call outright.
Source: MachTrader
At the time of this writing Tyler Craig had no positions in NEM.
