If you’re wondering what to buy on this dip, take a very hard look at Freeport McMoRan (FCX) LEAPS.
We are getting to the point where great equity trades with potentially huge returns are becoming few and far between. At the very least, they are only a fraction of the opportunities we saw a year ago, which was a once-in-a-century event.
So, when your trade of the century runs out, what do you do?
You find another trade of the century!
It just so happens I have another such animal.
You are all well aware of the cyclical bull market in base commodities and the coming “copper shock.”
How would you like to make a ton of money on this, a lot more, like three times more?
I have been dealing in the front-month options so far and managed to catch a 10X move in the shares of Freeport McMoRan (FCX). I think (FCX) shares could double from here. Here is how to maximize your profits.
Simply extend your maturities and lower your strike prices through LEAPS, or Long-Term Equity Anticipation Securities.
I’ll show you how to do that, first with a conservative position, and then a much more aggressive one. Better yet, an excellent entry point for both positions is close.
The case for higher copper prices is overwhelming.
Sounds like a great long to me.
Currently, LEAPS are listed for the (FCX) all the way out until January 20, 2023.
However, the further expiration dates will have far less liquidity than near-month options, so they are not a great short-term trading vehicle. That is why entering limit orders in LEAPS only, as opposed to market orders, is crucial.
These are really for your buy-and-forget investment portfolio, defined benefit plan, 401k, or IRA.
Because of the long maturities, premiums can be enormous. However, there is more than one way to skin a cat, and the profit opportunities here can be astronomical.
Like all options contracts, LEAPS gives its owner the right to "exercise" the option to buy or sell 100 shares of stock at a set price for a given time.
LEAPS have been around since 1990, and trade on the Chicago Board Options Exchange (CBOE).
To participate, you need an options account with a brokerage house, an easy process that mainly involves acknowledging the risk disclosures that no one ever reads.
If LEAPS expires "out-of-the-money" by the expiration date, you can lose all the money you spent on the premium to buy it. There's no toughing it out waiting for a recovery, as with actual shares of stock. Poof, and your money is gone.
Note that a LEAPS owner does not vote proxies or receive dividends because the underlying stock is owned by the seller, or "writer," of the LEAPS contract until the LEAPS owner exercises.
Despite the Wild West image of options, LEAPS are actually ideal for the right type of conservative investor.
They offer vastly more margin and more efficient use of capital than traditional broker margin accounts. And you don’t have to pay the usurious interest rates that margin accounts usually charge.
And for a moderate increase in risk, they present hugely outsized profit opportunities.
For the right investor they are the ideal instrument.
So, let’s get on with my specific examples for the (TLT) to discover their inner beauty.
By now, you should all know what vertical bull call debit spreads are. If you don’t, then please click here for my quickie video tutorial (you must be logged in to your account).
Warning: I have aged since I made this video.
Today, the (FCX) is trading at $42.86
The cautious investor should buy the (FCX) January 2022 $45-$50 vertical bull call debit spread for $1.65. Some 60 contracts get you a $10,000 exposure. This is a bet that (FCX) will rise above $50 in eight months. Sounds like a total no-brainer, doesn’t it?
expiration date: January 21, 2022
Portfolio weighting: 10%
Number of Contracts = 60 contracts
Here are the specific trades you need to execute this position:
Buy 60 January 2022 (FCX) $45 calls at………….………$7.00
Sell short 60 January 2022 (FCX) $50 calls at……….…$5.40
Net Cost:………………………….………..………….…..............$1.60
Potential Profit: $5.00 - $1.60 = $3.40
(60 X 100 X $3.40) = $20,400 or 104% in eight months. In other words, your $10,000 investment turned into $20,400 with an almost sure thing bet.
This is a bet that the (FCX) will stay above $50 by the January 21 option expiration in eight months.
Let’s say that you’re so convinced that exploding copper prices will cause the (FCX) to crash again that you’re willing to take on more risk and place a bigger bet.
Here is your dream trade:
Buy the (FCX) January 2023 $55-$60 vertical bull call debit spread for $1.00. Some 100 contracts get you a $10,000 exposure. This is a bet that (FCX) will rise above $60 in 20 months.
That’s what you would expect to see during a normal economic recovery. This is the greatest economic recovery of all time.
expiration date: January 20, 2023
Portfolio weighting: 10%
Number of Contracts = 100 contracts
Here are the specific trades you need to execute this position:
Buy 100 January 2023 (FCX) $55 calls at…………...………$7.50
Sell short 100 January 2023 (FCX) $60 calls at…..………$6.50
Net Cost:………………………….………..………….…................$1.00
Potential Profit: $5.00 - $1.00 = $4.00
(100 X 100 X $4.00) = $40,000 or 50.00% in 20 months. In other words, your $10,000 investment turned into $40,000 with an almost sure thing bet.
This is a bet that the (FCX) will stay above $60.00 by the January 20, 2023 options expiration in 20 months.
Why do a call spread instead of just buying the $50 calls outright?
You need a much bigger upside move to make money on this trade. By paying only $1.60 instead of $6.00 for a position you can quadruple your size, from 15 to 60 contracts for a $10,000 commitment. That quadruples your upside leverage on the most probable move in the (FCX), the one from $45 to $50.
That’s what real hedge funds do all day long, find the most likely profit and leverage up on it like crazy.
Let’s do the math on the two positions. If you buy the (FCX) January 2022 $45-$50 vertical bull credit spread for $1.60, you reach a maximum value of $5.00 on expiration day at $50.
If you buy the (FCX) January 2022 $50 calls outright, at $50 on expiration day your position is worth zero, nada, bupkiss. It gets worse. To make the same amount of profit as the spread the (FCX), or $20,400, it has to rise all the way to $53 to break even. Below that, you make more money than the spread, but at a quarter the rate.
How could this trade go wrong?
There is only one thing. We get a new variant on Covid-19 that overcomes the existing vaccines and brings a fourth wave in the pandemic.
In this case the (FCX) doesn’t rocket to $60 but collapses to $20 or more. We go back into recession. Both of the above positions go to zero. But if we get a fourth wave, you are going to have much bigger problems that your options positions.
So there it is. You pay you money and take your chances. That why the potential returns on these simple trades are so incredibly high.
Enjoy.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
And She’s Still on Her Learner’s Permit
