A Safe Way to Play Potash Corp.

Potash (POT) had a huge run up on much better than expected earnings and big estimate increases.

New 2008 estimates are around $9.80 or better.

The shares hit an all-time high of $215.97 recently as momentum investors piled in at the top. Thursday the shares were back down to $176.50 [11:30 AM price] or just under 18x the new estimate.

If you are a believer but cautious about buying this volatile a stock after a major price surge, here's a lower risk way to think about.

Sell [write] January 2009 puts at a well below market price.

Here is a play that looks interesting if you think POT shares will not tank between now and January 16th.

Sell POT Jan. 2009 $120 put @ $9.50 /share

The breakeven for the $120 is [$120 - $9.50] = $109.50 thus you have a 37.96% cushion even if the shares retreat some more. If POT stays above $120 through expiration you make $940 per contract [assuming a $10 commission].

The maintenance margin requirement on each contract is approximately 20% of the net purchase price of $109.50 or $2,300. Your best case return [if the option expires] is to make $950 on that theoretical $2,300 tie-up of marginable equity.

Your worst case scenario is to end up buying 100 shares [per contract] of POT at a net price of $109.50 per share or about 11.2x this year's estimated earnings.

Comments

[Paul Price]

There is a typo regarding the break-even price on this transaction. The correct break-even is $110.50 [not the $109.50 that appears].

Sorry for the error.

[GOLD]

That would be great if anyone was willing to buy Jan 09 120strikes. The chance of POT which will have 2009 EPS of between $14.50 low to $19.50 high hitting anything lower than $200/share is very very low.

Nice idea but you may need to up your strike a bit to find buyers.

[GOLD]

No one is buying $120 Jan 09 Puts. You would have to be Putz to buy 09 120strike Puts.

Good idea buy you will have to get a bit more aggressive on the strike. POT hasn't even started to realize the full increase in Potash prices. You could be selling 160's or 180's with a high degree of safety and bigger premiums.

Best,

[Paul Price]

I sold exactly the options I spoke about at the prices mentioned.

There are bids on every strike price all-day every day. You just need to plug in the option symbol to get a quote.

[Paul Price]

This was my trade confirmation from May 1, 2008:

05/01/2008 Settles 05/02/2008

Sold POTASH CORP SASK INC
JAN '09 @ 120 PUT - OPENING CONTRACT
ZFU MD 2 9.50 Principal 1,900.00 MGN 41 41441
73755LEMD Commission 2.00
Transaction Fee 0.02
NET AMOUNT 1,897.98

[Abe_d]

Paul-I'm new to option trading, so forgive me if this is a stupid question but isn't there some potential downside risk here if Potash were to drop well below the strike price...say to $70 or 60$ per share. Wouldn't you have to accept delivery of the stock at $120 per share when it is trading for much less?? I know this may be unlikely given Potash's earning power, but I'm just wondering.

[Paul Price]

Anything below $110.50 would create a paper loss.

POT finished at almost $198 today with the DJIA down > 200 pts.

I'd be happy to own it at $110.50 with expected 2008 EPS of
around $10.

[Gautam]

Smart advise. I play this strategy in the short term, and you can actually make money by just closing the position out before the option expires.