GIVEN ALL THE FUSS ABOUT European sovereign-debt problems and the implications of Quantitative Easing III, one of the worst droughts in U. S. history this past summer has gone largely unnoticed by many people.
As a result of the drought, supplies in grain crops are tight and crop prices remain well above historical trends. Moreover, prices are likely to remain above that trend, as any price elasticity would cause China – a major importer of potash – to raise its quotas.
There also are long-term fundamentals at play: people need to eat and animals must be fed. Thus, any signs of a revival in demand for agricultural products would give potash producers a shot of Miracle-Gro.
Canada’s Potash Corp. of Saskatchewan Inc. (recent price: $42.88 a share) and Agrium Inc. ($99.20 a share) are key players in this space. But when looking at the recent performance of their shares, you would wonder if they are in the same business. Agrium has turned in stellar numbers this year; Potash Corp.’s shares have essentially tracked the performance of the overall Canadian market.
There are risks, of course – more so in this sector, as these companies are key players in the “risk on/risk off” (RO/RO) swing trade. Rapid sentiment shifts add to volatility and make it more difficult to assume a longer-term view.
Another complicating factor is that premiums on agricultural stocks tend to trade in the top tier of implied volatility among Canadian equity-related options due to RO/RO. That causes traders interested in taking a position in this space to focus on option-writing strategies. Assuming you have a short- to mid-term bullish bias, consider steering your clients toward covered call writing or naked put writing strategies.
If your client owns the shares or is looking to trade inside registered accounts, then covered call writing – buying the underlying stock and writing a covered call against it – is the only choice.
With Potash Corp., look at buying the shares and writing the April 44 calls for a $3 a share premium. The seven-month return, if exercised, is 10.3%; the return, if unchanged, is 7.5%.
Similar numbers are available for Agrium, for which your client would buy the shares and write the April 100 calls at $7.50. The seven-month return, if exercised, is 9.05%; the return, if unchanged, is 8.2%.
The uncovered, cash-secured put write delivers similar results. With the sale of an uncovered put, your client is assuming an obligation to buy the underlying shares at the strike price of the short put. To maintain a cash-secured position, your client must set aside sufficient cash to buy the shares should the put be assigned.
With Potash Corp., you might look at writing the April 42 puts at $3.20. Your client should be willing to own the shares at the $42 strike price. If the puts are assigned, your client’s net cost is $38.80 a share, which is calculated as the strike price less the $3.20 premium received. If the shares are above $42 at the April expiration, the put will expire worthless and your client retains the premium.
With Agrium, write the April 98 puts for $7.25. If the put is assigned, your client’s net cost to buy the shares is $90.75 a share. If the stock price is above $98 at the April expiration, the put will expire worthless.
© 2012 Investment Executive. All rights reserved.