This Is An Undervalued Stock You Don’t Want To Own
However, by using options contracts to control 100 shares of the stock you can reap huge rewards, upwards of 100% and higher, with limited downside. With the stock now bottoming to long-term support levels, now is the best time to buy these options contracts.
DIGGING OUT OF A HOLE
The U.S. dollar direction has had a major impact on the stock market, especially commodity and resource stocks. The epic 2015 decline saw energy and metal plays pummeled because of Fed rate hike fears that ultimately proved to be unfounded.
Gold and oil bottomed to begin the New Year with a second chance pause in the last weeks to buy back into the bouncing sectors.
Metal giant Freeport McMoRan (NYSE: FCX), the largest publically traded copper company with additional gold reserves to tap into, had been beaten down from $40 in 2014 to $4 extreme lows. It’s now back up to just over $10.
As stocks have moved sideways in the last three months for with the S&P 500 gain of 3%, FCX has fallen back losing almost double digits over that same period.
This pullback to $10 support was a much-needed break for bullish buyers.
FCX has been stuck between $10 and $14 over the last six months. A move above the $12 midpoint of the channel track is a signal that the stock will attack the annual top.
Let me show you how a modest move just back to the May $14 top would see nearly a 100% gain using the right limited risk option. This proposed play also has lower investment cost and risks than buying the stock shares.
SIMPLE STOCK SUBSTITUTION STRATEGY
A stock substitution strategy using options ties up less capital and has absolutely limited risk to the premium paid. Option contracts also have greater staying power for long-term trend development.
Right now, I think the January option, which has more than four months plus for a Bullish development, is the best contract to play this trend. Giving the stock four months to reach our $14 price target gives us plenty of time to make this trade.
Buying an In-The-Money option gives you the right to long the shares from a lower strike price and costs much less than purchasing the stock itself, so that is how you turn a couple dollar improvement in this stock into a 100% gain.
The Options Way: Unlimited Upside Potential with Limited Risk.
A FCX long call option can provide the staying power in a potential bullish trend extension. More importantly, the maximum risk is simply the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.
With FCX trading at $10.65, for example, an In-The-Money $8.00 strike option currently has $2.65 in real or intrinsic value. The remainder of any premium is the time value of the option.
Trade Setup: I recommend the FCX January $8.00 Call at $3.25 or less. Only a close in the stock below $9.00 on a weekly basis or the loss of half of the option premium would trigger a position exit.
An option play also has staying power with the ability to ride through ups and downs that would force most stock traders out of the position.
The option behaves much like the underlying stock with much less money tied up in the investment. The Delta on the $8.00 strike call is 83%.
The January option has four months plus for bullish development. This option is like being long for the stock from $8.00 with completely limited risk. FCX was last down at the $8.00 discounted level in March.
The maximum loss is limited to the $325 or less paid per option contract, with a stop loss exit at half of that premium paid to limit dollar risk.
The upside potential, on the other hand, is unlimited.
The FCX option trade break even is $11.25 or less at expiration ($8.00 strike plus $3.25 or less option premium). That stands less than 75 cents above the current FCX price.
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Note: The author of this article is Alan Knuckman.
Category: Options Trading
