THIS Sector Offers a Compelling Asymmetric Trade
By: Chris Tell
We recently discussed the asymmetry available in the gold mining stocks here. We showed the spectacular returns that have been achieved by investing in beaten down sectors since the 1920's. Just the facts on what the past has shown us. We offer no guarantees to what the future holds, but we are placing our money where our mouths are.
Barrick Gold just announced some terrible news and the stock rallied slightly, but DID NOT fall. Barrick was the subject of a special "Trading Gold" report we recently published. Brad's (our trader) timing seems to have been spot on. It may be too early to say, but this is exactly what we spoke about in our article "Buying Bombed out Equities for Outsized Returns". This is typically what you see with a sector bottoming.
Incidentally I just watched an interview with Rick Rule, who believes that "today's bottom matches the 2000 Junior Resource Market". Now is Rick selling his own book? Probably...but I wouldn't accuse myself of being as knowledgeable on the sector as Rick, and as mentioned above the market is showing all the typical signs found at the bottom.
A long time reader and subscriber to Brad's trade alerts commented on the Barrick Trade Alert, which you can read in its entirety here. He wanted to know if the same applied to uranium stocks, another beaten down resource sector. He said the following:
This trade had me wondering about uranium and a potential uranium trade. Since in this article we are dealing with the largest Gold company, I was wondering if a similar trade could be done with Cameco, the largest uranium company. I am bullish uranium long term and I think by 2016 uranium should be much higher. So, I was wondering with regards to a vertical call spread on 2016 Cameco call options. I am not a pro on which call options to use and at what price, but maybe this could also be a trade in the future. Maybe Brad could take a look at it if he is also bullish on uranium long term.
I've been following the uranium market loosely. It is part of a watch list of sectors which I keep an eye on. It is certainly beaten up, but I don't know much more than what the average Joe probably knows. A big run up a few years back, Fukushima, bad juju for the sector, price collapse, coming up to a probable bull run just on cycles. Nothing extraordinary in terms of knowledge, so I got one of our analysts to dig for me and this is what we found.
- Breakeven price for producers - $70-$80/lb;
- Current price (over past 5 years) $20-$35/lb;
- Demand has continued to increase (even with Fukushima), supply has not kept up;
- Supply has come from above ground stockpiles (HEU Agreement);
- Final shipment for above agreement which supplied fully 24 million lb of Uranium each year was Dec 2013;
- Min amount of time to get a new uranium mine into production - 5 years;
- New demand? - 72 new reactors under construction with 62 of them expected to be completed by 2016.
The above is a tiny snapshot, and I've just highlighted the key points I think worth mentioning.
I shot the question over to Brad to get his views, and in true Brad fashion he came back with a well researched, thoughtful answer.
With respect to Cameco, I too am rather bullish more from a contrarian point of view and the fact that options are so cheap.
If you agree with our premise the next question is how to effectively apply a bullish view.
Well it starts with the volume of Cameco. Below is an index of 12 month implied volatility on Cameco options. It is close to record lows - clearly no one thinks that the price of Cameco will move at all over the coming months. But this is exactly where our asymmetry comes from, as options are priced way too low.
Given that options are priced so cheap all we need to do is to buy January 2016 calls with a $22 strike (at the money) calls. This will cost $3.50, giving a breakeven of $25.50. If CCJ was to get to 30 by January 2016 (not a tall order) it would result in a return of 130%.
Alternatively a more aggressive position could be established using an 'out of the money' bull call spread, in this case buying the January 2016 $25 and selling the January 2016 $35 strike @ $0.75 or better.
If CCJ was to close at or above $35 on expiry it would result in a gain of 372% (1000 - 180/180). Below is how the trade would appear on the Interactive Brokers platform:
Hopefully this addresses the problem of 'how to apply a bullish view on uranium.'
This is not an official Trade Alert that we have sent to our subscribers, but if you DO want to receive Brad's trades, you can do so HERE. The Trade Alerts are still complimentary for a limited time.
"I think that we cannot survive without Nuclear." - Masakazu Toyoda (Chairman of the Institute of Energy Economics in Japan)
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