Call Bull Spread On Potash
The Dynamic Wealth Report
April 23, 2008
Make Money With An Agriculture Trade
I love earnings season. It’s a great time to capitalize on the craziness
of the market. It also gives us an opportunity to profit by smartly
trading options. If you remember back in October I pointed out a trade. One of the solar companies was going to announce their earnings. Most of
their competitors had announced record results driving the stocks
significantly higher. We were right and people made money.
I see another trade like that setting up right now. . . but in a
different industry.
Now, this trade isn’t for the faint of heart. It’s risky. But the
profits could be nice as well. First a little background.
We all know how well commodities have done over the last few months and
years. To add fuel to the fire, China continues to drive demand for
food-related commodities. News of hoarding grains like rice and corn are
also floating around.
Needless to say, everyone loves the agricultural commodities.
As a result, the companies providing products and services to the
agricultural industry are thriving. Just look at DuPont (DD). The
company announced earnings Tuesday. The strength of their business was
found in agriculture. First quarter profits were up 26% . . . all due to
increasing demand for its seed products and agricultural chemicals.
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Now the stock is down a bit, but that’s because they indicated product
sales were slow in other groups, namely automotive and construction.
Yet another signpost.
Monsanto (MON), the giant agricultural products supplier announced their
earnings on April 2. They had previously raised guidance in March. So
everyone knows the agricultural products industry is white hot. In the
earnings announcement management highlighted expectations of a 58% to
63% earnings growth this year! When Monsanto earnings hit the tape the
stock rallied.
Monsanto had traded as low as $105 on the day of the announcement. It
hit $124 over the next few days . . . and continued higher.
So, what’s next.
Tomorrow, April 24, Potash (POT) is going to announce earnings at
1:00 pm eastern time. If you trade this stock just right, you might make
some money.
Now for those of you who don’t know, Potash is a very interesting
company. They’re the world's largest potash company. They’re also the
third largest phosphate producer and the second largest nitrogen
producer in the world. All of these products are needed in the
agricultural industry.
The company has been selling these agricultural products since 1953, and
it looks like they’re on track for a record year.
Some interesting news.
Just a few days ago Potash announced a significant price increase of
their products to China. Prices went up more than $400 per ton on “red
standard grade potash.” Now this isn’t the first price increase for the
company.
Nope. A few days earlier on April 9th, they raised rates for North
America. And a few days prior to that, they raised prices in South East
Asia and Latin America. Basically prices are up around the world.
Increasing prices is always difficult. You run the risk of customers
either not buying your product or searching for a new supplier. What
Potash basically said was “we don’t care.”
Like the Godfather they made ‘em an offer they couldn’t refuse.
Now think about this for a moment. If you can push through a major price
increase on your best customers, then you have substantial power in
price negotiations. This means there’s more demand than supply in the
market place.
And since Potash controls the supply, they control the price.
So what does this all boil down to? I’m trying to figure out if Potash
is going to make their numbers on Thursday. Something tells me they
will. I think not only will they make their numbers; they’ll beat ‘em.
But there’s a risk.
Lots of people already see what we see. This big home run may already be
priced into the stock. If that’s the case, the stock might go nowhere on
the news. It might even go down. And of course there’s the wild card. You never know what management is going to say about future
expectations. They could throw everyone a curveball and the stock might
get destroyed.
I find it hard to believe that will happen. . . . but you never know.
The last time Potash announced earnings was back in January. The stock
traded as low as $105. A few days later it had rallied to $144. Of
course they announced record revenue, EBITDA, and profits.
So how can we profit this time around?
Buying calls on Potash is one way to profit if the stock jumps in value. I looked at the short term options. Right now, you can buy May calls on
Potash with a strike of $210 for about $15 each. If you put on this
trade, you’d profit when the stock rallied above $225. That’s a $28
point move in the stock.
I know what you’re thinking, these options are expensive. They are.
There’s an advanced options trading technique that can lower your cost
dramatically, but it also limits your profits. It’s known as a
Call Bull Spread.
First you buy a close to the money call option and at the same time sell
a call option at a higher strike price. Your maximum profit would occur
when the stock trades above the higher strike price. It’s a way to
potentially gather some profits, but remember, if the stock doesn’t move
in the right direction, you can lose your entire investment.
As with any option trade there are risks. Make sure you’re comfortable
with and fully understand the risks and rewards of every trade – before
you buy a position.
• Wheat ($8.60 per bushel)
Wheat prices have retreated over the last few weeks. After peaking above
$13 in late February news of increasing global production pushed prices
lower. India recently announced official estimates indicating wheat
production would reach all-time records this year.
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