Monsanto (NYSE: MON) has been in takeover discussions for months. Recently, discussions swirled surrounding a PotashCorp (NYSE: POT) and Agrium (NYSE: AGU) merger, surging the entire sector higher. As technicians, we generally don’t care about the news, but rather a compelling chart pattern with favorable reward-risk setup – particularly with the use of options.
We have been watching the longer term charts of the fertilizer stocks for weeks now since the weekly and monthly charts have been consolidating after a massive selloff. We have been waiting for some bullish surge to suggest that this bottom is solid. This week’s surge gave us that indication. So let’s go shopping!
Here is the weekly chart of MOS:
Two days ago, MOS closed with a bullish wide range igniting bar (+WRB) on the daily chart (not shown), surging through resistance and closing strong. You can see this on the weekly chart. This suggests the start of a new uptrend (i.e., breakout from consolidation). Yesterday was a bullish inside day so it is ripe for new entries. Although I have been selling Sep and Oct puts on it over the past two days, let’s analyze the math on the Dec options which expire in 106 days (the third Friday in December 2016).
Above are select Dec put closing prices of MOS. MOS closed at $30.07. An investor could purchase 1,000 shares of MOS for $30,070; however, let’s compare that to selling some Dec puts. The $30 puts are considered “at-the-money” (ATM). One could sell a 10-lot of the Dec 30 MOS puts for $2.70/share, generating $2,700 in premium. This would give a cost basis of $27,300 if assigned, a 9% discount to the stock buyer (significantly higher if annualized). The only downside to the put seller, however, is that the premium received of $2,700 is the maximum gain, whereas the stock buyer has unlimited gain.
Personally I am a trader and not investor, so I prefer selling the further OTM puts. For example, one could sell a 10-lot of the Dec 25 MOS puts for $.84/share, generating $840 in premium. This would give a cost basis of $24,160 if assigned, a staggering 19.4% discount to the stock buyer. So, to me, with this bullish chart pattern, I am happy with either outcome: make $860 in profit in 109 days, or own MOS at a 19.4% discount (although I would stop out of it since the stop must be under the massive support area or else something went terribly wrong with the company).
There are other bullish option strategies one could deploy depending on how bullish the trader is. One of my favorites on longer term directional trades is a bullish call diagonal. This involves buying the Dec ITM call (e.g., $25 call) and selling the closer expiring OTM calls against it as the stock slows in momentum.
Here is the weekly chart of POT:
Similar to MOS, POT closed with a +WRB on the daily chart (not shown), surging through resistance and closing strong. You can see this on the weekly chart. This suggests the start of a new uptrend (i.e., breakout from consolidation).
Below are select Dec put closing prices of POT, which closed at $18.10.
You can follow my example above and calculate the reward-risk for selling the 15-18 puts per your risk tolerance. Notice, however, that the strikes below $15 have horrible spreads. Never trade those! Liquidity is a key prerequisite to trading options (unless, as mentioned before, you get filled at inside market and you don’t mind being assigned, as opposed to simply trading it).
Something to be aware of on all of these stocks is that the spreads have significantly widened with the news so never pay the quoted price – work the mid-point and/or try to sell as “low offer.”
Other stocks to watch in the sector include MON, AGU and CF, although the wide spreads have generally made them untradeable. As a trader, I typically only focus on the top 120 most liquid options which have tight spreads. NOTE: With the sector retracing a bit today, put sellers should receive even larger premium amounts then mentioned above.
Happy trading! If you have any questions or comments, please e-mail Dan Gibby at Dan@gregcapra.com
