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Dark Horse Traders' Hedge: Ride out the Storm with FCX, Option Review

Courtesy of Scott Brown, Sabrient Systems and Gradient Analytics

 

Riding the storm out, Waiting for the fallout

On a full moon night in the Rocky Mountain winter

Wine bottle’s low, watching for the snow

I’ve been thinking about what I’ve been missing in the city

And I’m not missing a thing

Watching the full moon cross the range

Riding the storm out, Riding the storm out

REO Speedwagon

I was stuck in a Dallas hotel on October 29, 2012 trying to get to New York City.  The flights to JFK were canceled Monday and Wednesday due to Hurricane Sandy which has left the upper East Coast “Riding the Storm Out.”  I won’t add anything other than my prayers to those affected by this storm as the media has inundated us with plenty of information.

I will add one comment here related to the lyric “On a full moon night in the Rocky Mountain winter, Wine bottle’s low, watching for snow.”  For anyone who watched election night, you may have heard that Colorado has voted to legalize marijuana for recreational use. REO may want to make a change to the lyrics as it will be more than the “wine bottle” that is low on the “full moon night in the Rocky Mountain(s).”

Let’s turn our attention to Freeport-McMoRan (FCX) and the position we started on March 19, 2012 at $38.38. FCX is currently trading at $38.64, so we have been “Riding the Storm Out” for nearly eight months.  However, we have used options and dividends to generate additional gains on our position, so I’m sure “I’m not missing a thing.”  Recall that we sold the May $40 call and May $40 put when we started gaining exposure to FCX in March.  The May $40 call worked out just fine (+$1.42) but the May $40 put had to be repurchased on May 19, 2012 for $7.50 (-$4.59) while “looking for the fallout.”  We elected to roll into the August $40 put at that time for $8.20. 

My last post on FCX was August 14, 2012 where we closed the May $40 put for $4.60 (+$3.86) and rolled into the Nov $40 put for $5.45, which is the option we are reviewing today.  I recommend buying-to-close the Nov $40 put for $1.47 (+3.98 on the trade).  We also picked up dividends on July 11, 2012 (+$.313) and October 11, 2012 (+$.313).  All of this adds up to a cost basis of $33.46 on half the position we were willing to own in March.

The first order of business is to determine if FCX is still worthy of long exposure in our portfolio.  Last Friday we had “better-than-expected data from China, and the U.S. signaled improving demand in the world’s biggest metals users.”  Gold also climbed to a three-week high, and the underlying assets of Freeport-McMoRan are performing as we anticipated. The forward P/E of 8.22 is acceptable along with an attractive levered free cash flow exceeding $600 million. Analysts continue to see at least 40% growth in 2013 on earnings, so I am inclined to maintain long exposure in FCX.  The closing of the November $40 put leaves us holding half the desired position with a cost bases of $33.46, so we can sit back and “watch the full moon cross the range” earning dividends and earning option/time premium.  Given the expectation of extraordinary growth in 2013, we don’t want to cover the upside for long.  Therefore, I’m recommending sell-to-open the Jan $40 call ($1.63) and Jan $40 put ($3.20) to equal the other ½ shares we have been willing to own.

Post-election the market continues to “ride the storm out” in the face of the “fiscal cliff,” a very slow-growing domestic economy and abroad, and a divided Congress and House (among other things).  Meanwhile we have the “support” of QE3 and the continuous flow of new money into the system every month as far as the eye can see.  I continue to believe that equities are more likely to rise than fall from here, so I remain cautiously optimistic and tilted long.  Sectors that should benefit the most from the President’s re-election are Healthcare (see our exposure to Aflac on July 19, 2012) and Energy (more particularly some solar companies such as LDK).

In summary, we can continue “Riding the Storm Out” with exposure to stocks we like but earning option premium while waiting on the storm to end.

Recommendations:

Buy to close, FCX Nov $40 put (FCX121117P00040000) at the open Tuesday, November 13, 2012

Sell to open, FCX Jan $40 call (FCX130119C00040000) at the open Tuesday, November 13, 2012

Sell to open, FCX Jan $40 put (FCX130119P00040000) at the open Tuesday, November 13, 2012

 


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