Option Expiration Sets Rockwood Holdings Free, Buy/Write Rio Tinto

| About: Rockwood Holdings, (ROC)

If I leave here tomorrow
Would you still remember me?
For I must be traveling on, now
'Cause there's too many places I've got to see
But, if I stayed here with you, girl
Things just couldn't be the same
'Cause I'm as free as a bird now
And this bird you can not change
And this bird you can not change
And this bird you can not change
Lord knows, I can't change

Bye, bye, baby it's been a sweet love
Though this feeling I can't change

But please don't take it so badly
'Cause Lord knows I'm to blame…

"Freebird" -- Lynyrd Skynyrd

In my last post, we discussed one of the most frequently asked questions: when to sell a stock. Sometimes, when we use options to gain exposure to the position and earn time premium, the decision is made for us. Like Lynyrd Skynyrd says, "don't take it badly, 'cause Lord knows I'm to blame." As for Rockwood Holdings (NYSE:ROC), we "must be traveling on now" but "it's been a sweet love."

Rockwood Holdings, Inc. was originally recommended for long exposure on October 6, 2011 at $36.19 as a "bargain." As you'll likely recall, the markets were in a volatile downspin in October 2011, and when volatility is high, so are option premiums. The Feb $40 call and put were recommended to take advantage of these premiums. Honestly, my thought in October was that we would be rolling these options in February, as I believed the stock would rebound to around $40. The Feb $40 call yielded us $3.80, and at the same time, the market was willing to pay us $7.75 for the Feb $40 put. In retrospect, with ROC closing Friday, February 10, 2012 at $54.02, I suppose buy and hold actually would have netted a few extra points. The final tally for this trade is that we were exposed to ROC for slightly more than 4 months at an entry price of $36.19, profited $11.55 in option premiums, and will exit on Friday, February 16, 2012 at $40. "And this bird you cannot change," and I will not complain about a 42% profit. Like I noted earlier, "it's been a sweet love," but "if I stayed here with , things just couldn't be the same."

RIO Tinto Plc (NYSE:RIO) is my choice for replacing ROC as one of the new "places I've got to see." There is a lot to like about RIO which engages in titanium dioxide feedstocks, talc, high purity iron, salt, metal powders, zircon, rutile, thermal and coking coal, uranium, and iron ore. It primarily operates in Australia, North America, South America, Asia, Europe, and Africa. That part all sounds just fine, but the devil is always in the details. A dividend that was just increased 34% last week to $1.35, and $11.4 Billion in levered free cash flow are good enough reasons to be long. Analysts anticipate 2012 earnings of $9.32, meaning we can get exposure to RIO for a forward P/E of only 6.5, and we can trim a bit off using the Phil Davis Buy/Write strategy to enter our position. I prefer using the Apr $62.50 call (RIO120421C00062500) for approximately $2.05 and the Apr $62.50 put (RIO120421P00062500) for approximately $4.80, yielding $6.85 in option premium on April strikes for a stock we like exposure to at $60.61. We can enter this position this week because ROC will be called away making us "as free as a bird now."


  • Allow ROC to be called away Friday, February 16, 2012 at $40 (keeping $11.55 in option premium)
  • Buy to open RIO, at the market
  • Sell to open RIO Apr $62.50 call, at the market
  • Sell to open RIO Apr $62.50 put, at the market

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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