As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price.
Trade Alert – (FCX)
Buy the (FCX) February, 2013 $30-$33 Bull Call Spread at $2.52 or best
expiration date: 2-15-2013
Portfolio weighting: 10% = 40 Contracts
I have been following Freeport McMoRan (FCX) for about 30 years now, and it has long been one of my favorite companies, as it is one of the world’s purest plays on copper. I followed it during the dark days when the red metal was trading in the basement at $0.70/pound, and liked it just as much when copper hit $4.75 in 2011. Another plus is that I know the senior management are regular readers of his letter.
So when the stock cratered by 20% on a merger announcement, a new 14-month low, I sat up and took notice. Specifically, it said it would pay $9 billion for Plains Exploration & Production, and oil producer, and a second company, McMoRan Exploration Company, which it had previously owned until. That’s a big bite to swallow for a firm that has a remaining market capitalization of $27 billion. The deal will be financed by $11 billion in new debt.
(FCX) is clearly looking at China’s soaring energy demand as an impetus to get back into the oil business. They agree with my own analysis that the US is well on its way to becoming the world’s largest energy exporter. These acquisitions give them skin in the game, with stakes in oil shale formations in Texas and Louisiana, fields that I once owned myself.
They will also get a presence in offshore production in the Gulf of Mexico, an area that was always too rich for my blood, with drilling costs starting at $10 million a well. The new, larger company will earn about 74% of its income from copper and gold mining and 26% from oil and gas.
The bears dumped the stock for a number of reasons. The company passed on a special dividend in order to fund the takeovers because it feels it will get a much greater bang per buck over the long term. The premium paid was substantial, and the increased leverage will certainly weaken the balance sheet.
The real reason I want to do this trade is that I believe we are not far from seeing a turnaround in the Chinese economy, which has been shrinking for three years. Traders thought as much when they ran the Shanghai stock market up a blazing 16% in a month, the best move in years.
Now that the new government is in place, the path is set for them to announce an additional round of stimulus to get the economy back on track. If so, that would be spectacular news for oil, copper, and gold, all of the new FCX’s products. Think of (FCX) as a cheap call on China.
The long-term case for copper is still compelling. The Chinese drive for a higher standard of living is irresistible, and that requires enormous amounts of copper for roads, construction, and shipbuilding. China accounts for more than 50% of the global demand for copper. A burgeoning global hybrid and electric car industry is also increasing demand for copper.
We are also at a level in the shares, just above $30, where value players start to come into this name. That puts the shares at a bargain basement 4X EBITDA. The 3.10% dividend yield is an additional kicker, nearly double the ten year Treasury bond yield.
The best execution can be had by placing your bid for the entire spread in the middle market and waiting for the market to come to you. The difference between the bid and the offer on these deep in-the-money spread trades can be enormous. Don’t buy the legs individually or you will end up losing much of your profit up front. If you don’t get filled, then just wait for the next Trade Alert. There will be many fish in the sea.
The same applies if, for any reason, you don’t understand this trade. Better to watch this strategy unfold on paper in the model portfolio before you try it with real money.
Keep in mind that these are ballpark prices only. Spread pricing can be very volatile on expiration months farther out.
Here are the specific trades you need to execute this profitable position:
Buy 40 X (FCX) February, 2013 $30 Calls at………………. $5.00
Sell short 40 X (FCX) February, 2013 $33 calls at………….-$2.48
Net Cost………………………………………….…………. $2.52
Maximum profit at expiartion = $3.00 – $2.52 = $0.48
($0.48 X 100 X 40) = $1,920, or 1.92% for the notional $100,000 model portfolio.