Mosaic Company (NYSE: MOS) fell from grace in 2013 thanks to the breakup of the Uralkali/Belaruskali potash cartel and plummeting grain prices. In fact, in a banner year for stocks, we see MOS is almost the mirror image of the broader market S&P 500.
With corn prices below $5 per bushel, their lowest level since 2010, and soybean prices below $14 per bushel, it will be important for farmers to get the maximum yield from every acre, which means increased demand for the crop nutrients produced by Mosaic.[ad#Google Adsense 336×280-IA]Additionally, there is speculation of a potash cartel reunion, which would help boost potash prices.
I think the risk/reward in MOS favors the bulls at these discounted levels.
The stock held above its 2010 lows just below $40 on last year’s pullback.
The eight-month trading range from $40 to $50 targets $60 on an upside breakout.
Only a close below the $40 channel support level on a weekly basis would negate the bullish trend.
The $60 target is about 24% higher than recent prices, but traders who use a capital-preserving, stock substitution strategy could more than double their money on a move to that level.
One major advantage of using a long call option rather than buying a stock outright is putting up much less capital to control 100 shares — that’s the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.
You want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:
Rule One: Choose a call option with a delta of 70 or above.
An option’s strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)
It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they’re worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.
The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option’s delta using an options calculator, such as the one offered by the CBOE.
With MOS trading near $48.45 at the time of this writing, an in-the-money $40 strike call option currently has about $8.45 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option currently has a delta of about 83.
Rule Two: Buy more time until expiration than you may need — at least three to six months — for the trade to develop.
Time is an investor’s greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.
With these rules in mind, I would recommend the MOS Jan 2015 40 Calls at $9.75 or less.
A close below $40 in MOS on a weekly basis or the loss of half of the option’s premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $975 or less paid per option contract. The upside, on the other hand, is unlimited. And the January 2015 options give the bull trend almost 10 months to develop.
This trade breaks even at $49.75 ($40 strike plus $9.75 options premium). That is a little more than $1 away from MOS’ recent price. If shares hit the $60 target, then the call option would have $20 of intrinsic value and deliver a gain of more than 100%.
Recommended Trade Setup:
— Buy Mosaic Company (NYSE: MOS)Jan 2015 40 Calls at $9.75 or less
— Set stop-loss at $4.87
— Set initial price target at $20 for a potential 105% gain in 10 months