Options Update: Potash Corp. of Saskatchewan Calls Popular as Shares Rally

With the banking and financial sectors dominating the headlines in recent weeks, you may have missed a budding rally forming for agribusiness specialist Potash Corp. of Saskatchewan
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The company mines, produces, and sells potash, phosphate ore, phosphoric acid, nitrogen fertilizers, nitrogen chemicals, and animal feed products. The recent plunge in commodities prices had a negative impact on POT shares, but the stock has rebounded more than 8% so far in 2009. What’s more, the equity has bested the S&P 500 Index (SPX) by more than 10% on a relative-strength basis during the past 60 trading days.

Seemingly focused on the stock’s weak performance in the latter half of 2008, options traders have piled into put options on POT. Currently, the security’s Schaeffer’s put/call open interest ratio (SOIR) of 0.98 ranks above 88% of all those taken during the past year. This ratio indicates that options traders have been more negative toward the equity only 12% of the time in the prior 12 months.

Furthermore, the International Securities Exchange and Chicago Board Options Exchange’s 10-day put/call volume ratio of 1.23 rests at an annual high. Not only does this ratio reveal that puts bought to open have outnumbered purchased calls during the past 2 weeks, but it also means that speculative options traders have not had a bigger appetite for purchased puts relative to calls during the prior 52 weeks.

Fast forward to today’s activity in the options pits, as it seems that investors might be on the verge of a change of heart. Specifically, more than 20,000 POT calls have traded so far today, more than doubling the stock’s average daily call volume and placing the shares on our Intraday Volume Explosion List. Looking at the chart below, you can see that practically all of today’s activity is changing hands at the ask price, suggesting that these options are being bought to open – i.e. the initiation of new long positions on POT.

Potash option volume details

The Anatomy of a Potash Call Position

Scanning today’s POT call data, I noticed that 4 blocks totaling 1,647 contracts changed hands at the ask price at 10:27 a.m. Eastern time on the same exchange – suggesting that they were part of a larger position. Assuming these blocks are related, the total outlay for this position would be $279,990 — (1.70 * 100)*1,647 = $279,990. For this trade to reach breakeven, POT would need to rally about 28% to $101.70 per share from yesterday’s close of $79.44 per share before the options expire on March 20. The maximum loss on this position is limited to the initial investment of $279,990.

By entering this trade, the investor is indicating that he expects POT to rally sharply during the next several weeks. The shares have jumped nearly 6% so far this afternoon, starting today’s trading example off on the right foot. That said, let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

As mentioned at the beginning of today’s POT analysis, the stock has performed admirably since the beginning of 2009. While the shares have gained about 8.5% since the beginning of the year, the SPX has fallen nearly 8% during this time frame. The stock’s uptrend has been slow but steady, garnering support from its 10-day and 20-day moving averages. POT has even bested potential round-number resistance at the 80 level, and is poised to close its first week above its 10-week and 20-week trendlines since July 2008.

There is one technical hurdle that could spoil the security’s quest for higher ground: the 85 level. Since breaking below this region in mid-October 2008, the shares have been unable to stray far from this roadblock, recording only 4 breaches on an intraweek basis and only 1 weekly close above this level. Support has been strong for POT, with the shares remaining largely range-bound between the 65 and 85 levels since October. However, the shares are riding a wave of momentum that could help them blow past this overhead resistance.

Daily chart of Potash GameStop since October 2008 with 10-day and 20-day moving averages

The Sentiment Drivers

Sentiment toward the equity is a bit mixed at the moment. While options players are heavily bearish toward the shares, Wall Street analysts are singing POT’s praises. In fact, 7 of the 9 brokerage firms following the security rate it a “buy” or better, with no “sell” ratings to be found. Meanwhile, short sellers hold less than 2% of the stock’s float, resulting in a meager short-interest ratio of 0.40. That said, the number of POT shares sold short surged by more than 20% during the most recent reporting period. While this added selling pressure should have pressured the stock lower, POT has shrugged off the potential downdraft and continued higher – a testament to the equity’s technical strength.

Sentiment indicators for Potash

The Verdict?

While I like the idea of a POT call position, a March 100 call seems a bit too far out of the money for my tastes. Don’t get me wrong; if the stock manages to convincingly move past resistance at the 85 level, we could very well see the shares trading near the 100 mark. However, a more conservative position, such as a March 80 call, could be a safer bet with the prospect of psychological resistance at the century mark. What’s more, a March 80 call, currently trading with an ask price of $10.10, would need POT to rally only 7% to reach breakeven by expiration, versus the nearly 28% rally needed for a March 100 call.

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