Shares of copper miner Freeport-McMoran (NYSE 🙂 are up more than 41% so far. The stock has benefited from rising prices, currently at multi-year highs.
We previously covered copper miners (here and exchange traded funds that track the commodity here). On February 22, FCX shares hit its multi-year high of $ 39.10. Now the stock is hovering at $ 36.5.
Freeport-McMoran Weekly Chart.
Today we look at Freeport-McMoRan – which is expected to release its first quarter earnings on April 22 before market opening – to provide the current example of a covered call. Over the past few weeks, we've discussed how investors might consider writing covered claims for their share holdings.
Such an option strategy could help reduce the volatility of their position and provide shareholders with some protection against falls in the FCX stock price. Readers new to options may want to revisit the first article in the series before reading this post.
Freeport-McMoRan
Intraday Price: $ 36.42
52 Week Range: $ 7.30 – $ 39 , 10
Price change year-to-date: Up about 41%
Dividend Yield: 0.82%
Phoenix-based Freeport-McMoRan operates large and geographically diverse mining assets with copper and molybdenum reserves. The assets of FCX include the Indonesian mining complex Grasberg, one of the largest copper and mines in the world. It also has significant mining operations in the Americas.
The company published full-year figures at the end of January. Quarterly sales were up 14.9% year on year to $ 4.5 billion. Adjusted net income of $ 566 million translated into earnings per share of 39 cents.
Investors were pleased to see that fourth quarter copper and gold sales were 3% and 9% higher, respectively, than the October 2020 estimates. Average realized prices were $ 3.40 per pound for copper and $ 1,870 per ounce for gold. Keep in mind that prices for both metals are currently around $ 4.25 and $ 1,775.
CEO Richard C. Adkerson noted:
" We are excited about the future prospects for our business based on the positive outlook for the markets we serve, our long-lived and high-quality copper assets, our seasoned and highly motivated global organization, and the critical role of copper for the technologies needed to provide clean energy and support the global transition to a low-carbon economy. "
The mining group shared its consolidated sales volume expectations for the first quarter and full year 2021. Accordingly, Freeport-McMoRan expects to reach 825 million pounds of copper by Q1 2021 (compared to 729 million pounds of Q1 2020), 275,000 ounces of gold (compared to 144,000 ounces Q1 2020) and 20 million pounds of molybdenum (compared to 21 million pounds in Q1 2020).
The forward P / E and P / S ratios of FCX & # 39; are currently 16.39 and 3.84 respectively. Given the significant and rapid rise in the FCX stock price YTD, a covered call to protect some of the recent gains may be a suitable strategy for some investors.
Covered Calls on FCX ??Stocks
For every 100 shares held, the strategy requires the trader to sell one call option with an expiration date sometime in the future.
As we write on Tuesday, the FCX stock price during the day is $ 36.42. That's why we use this price for this post.
A stock option contract on FCX ??(or any other stock) is the option to buy (or sell) 100 shares.
Investors who believe that short-term profits could be taken soon, could use a somewhat in-the-money (ITM) backed call. A call option is ITM if the market price (here $ 36.42) is higher than the strike price ($ 35.00).
Thus, the investor would buy (or already own) 100 shares of FCX for $ 36.42 and simultaneously sell a May 21, 2021 FCX call option with 35 strikeouts. This option is currently offered at a price (or premium) of $ 3.05.
A buyer of an option would be required to pay $ 3.05 x 100 (or $ 305) in premium to the seller of the option. This call option will stop trading on Friday, May 21, 2021.
This premium amount belongs to the option writer (seller) no matter what happens in the future, for example on the day of the expiration date.
The 35-strike offers more downside protection than a phone call for money (ATM) or out-of-the-money (OTM).
Assuming a trader would now participate in this covered call trade at $ 36.42, at expiration the maximum return would be $ 163, i.e. $ 305 – (($ 36.42 – $ 35.00 ) x 100), excluding trade commissions and fees.
] Uncontrolled Covered Call Risk / Reward Profile
The maximum profit of an ITM covered call is equal to the extrinsic value of the short call option.
The net asset value would be the tangible value of the option if it were exercised now. Thus, the intrinsic value of our FCX Call Option is ($ 36.42 – $ 35.00) X 100, or $ 142.
Extrinsic value is the difference between the market price of an option (or its premium) and its intrinsic price. In this case, the extrinsic value would be $ 163 i.e. ($ 305 – $ 142). Extrinsic value is also called time value.
The trader realizes this $ 163 profit as long as the price of Freeport-McMoRan stock at expiration remains above the call option strike price (i.e., $ 35.0).
At maturity, if the stock closes below the strike price, the option would not be exercised, but would instead expire worthlessly. Subsequently, the shareholder with the covered call position receives the shares and the money (premium) that he / she paid for the sale of the option.
At maturity, this transaction would break even at an FCX ??share price of $ 33.37 (i.e. $ 35 – $ 1.63), excluding trading fees and expenses.
Another way to think of this breakeven price is to subtract the call option premium ($ 3.05) from the underlying FCX stock price when we initiated the covered call (i.e. $ 36.42).
On May 21, if the Freeport-McMoRan stock closes below $ 33.37, the transaction would start to lose money within this covered call setup. Thus, by selling the covered call, the investor has some protection against a potential loss in the event of a fall in the underlying stock. In theory, the price of a stock could drop to $ 0.
What if the Freeport-McMoRan stock hits a new record?
As we noted in previous articles, such a covered call would limit the upside profit potential. The risk of not fully participating in the potential appreciation of FCX shares would not appeal to everyone. However, within their risk / return profiles, others may find that acceptable in exchange for the premium received.
For example, if the FCX stock hit a new high in 2021 and close at $ 50 on May 21, the trader's maximum return would still be $ 163. In that case, the option would be deep ITM and likely exercised. A brokerage fee may also be charged if the shares are called away.
As part of the exit strategy, the trader could also consider rolling this deep ITM call option. In that case, the trader would buy back the 35 call before the expiration date expired on May 21.
Depending on his / her opinion and objectives regarding the underlying FCX stock, he / she might consider starting another covered call position. In other words, the trader could potentially roll out to a June 18 maturity call with an appropriate warning.
Ex-Dividend Date
Finally, we must remind readers that the Freeport-McMoRan stock ex-dividend in mid-July (exact date not yet known), a day that may be of interest for covered call writers. Since our proposed covered call expires before the next ex-dividend date, we don't care on this occasion.
However, if our covered call ends in July after that date, we should pay attention. To be eligible for the dividend payment, an equity investor must own shares before that ex-dividend date.
As the writer of the FCX covered call, the trader may be subject to early exercise as the buyer of the option may wish to receive this dividend.
Such early practice usually takes place the day before the ex-dividend date and, in the case of ITM options, which do not have much time value. Call writers should be aware of the ex-dividend date as the covered call strategy may need to be managed.
Bottom Line
The exact timing in the marketplace at which FCX stocks could take a breather is difficult to determine, even for professional traders. But options strategies provide tools that can prepare for sideways moves or even price declines, especially around the earnings release date.
We consider covered call options as a possible way to generate additional income from your equity portfolio. Such a strategy also helps reduce portfolio volatility. Interested investors might consider expanding their knowledge base.
