Options Update: Potash Corp. of Saskatchewan Attracts a Flood of Call Volume

Agricultural concern Potash Corp. of Saskatchewan
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has returned to the headlines this week, after the firm said it would reduce its 2009 potash output by 2 million tons, or 20%, due to slowing demand.

Following the news, RBC cut its price target on the shares to $145 from $175, but maintained its “outperform” rating. This morning, UBS followed suit, cutting its target on POT to $105 per share from $130. The brokerage firm held its “buy” rating despite the target cut.

While this type of news would normally have a negative impact on the shares, POT has rallied more than 13% since Tuesday. Like moths to the flame, options traders have also flocked to the security, as its Schaeffer’s put/call open interest ratio (SOIR) has edged lower from a reading of 0.43 on December 8 to today’s perch at 0.41, highlighting the recent preference for calls over puts among options traders.

Further illustrating the point, data from the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) reveals a 10-day call/put ratio of 1.99, meaning that calls bought to open have outpaced puts purchased by nearly 2 to 1 during the prior 2 weeks. This reading is also higher than 83% of all those taken during the past 52 weeks, underscoring the extremely bullish nature of this activity.

This trend has continued in today’s trading, with POT call volume more than doubling the stock’s daily average. Turning to our Intraday Volume Explosion List, I noticed that the most active contract was the December 70 strike, which has seen more than 6,900 calls change hands so far today.

Potash option volume details

The Anatomy of a Potash Call Position

Digging into this call activity, I noticed that a block of 200 contracts changed hands at 10:31 a.m. Eastern time at the ask price of $4.00. The total outlay for this position would be $80,000 — ($4.00 * 100)*200 = $80,000. For this trade to reach breakeven, POT would need to rally about 6.5% to $74 per share from yesterday’s close at $69.49 before the options expire on December 19. The maximum loss on this position is limited to the initial investment of $80,000.

By entering this trade, the investor is indicating that he expects POT to rally sharply during the next several weeks. The equity has garnered some momentum during the past week, but will it be enough to push the shares through overhead resistance? Let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

With the shares down more than 51% so far this year, a call position on POT seems an unlikely candidate for a profitable trade. The majority of the stock’s losses have occurred since mid-June, as the shares have plunged more than 70% since setting a near-term peak of $241.62 on June 19. During this time frame, POT has battled resistance at its 10-week moving average – a trendline the shares have not closed a week above since early July. Today, the security is attempting to break through short-term resistance at the 70 level. However, POT’s 10-week moving average is once again limiting the stock’s upside potential and putting a crimp in returns for December 70 call buyers.

Weekly chart of Potash since June 2008 with 10-week moving average

The Sentiment Drivers

On the sentiment front, Wall Street analysts largely agree with the bullish expectations found in the options pits. Currently, 6 of the 10 brokerage firms following POT rate the shares a “buy” or better, according to Zacks.com. Elsewhere, Thomson Financial reports that the stock’s average 12-month price target rests at $111.40 per share – a 60% premium to POT’s Wednesday close. Any downgrades or price-target cuts, like those mentioned above, could spark another round of selling pressure on the security.

Meanwhile, short sellers have just said no to POT. Only 5.35 million shares have been sold short, accounting for roughly 1.8% of the company’s total float. This lack of short interest indicates that investors do not have particularly low expectations for the security.

Sentiment indicators for Potash

The Verdict?

While the stock’s recent momentum is encouraging, POT remains encumbered by overhead resistance at its 10-week moving average. What’s more, practically no investors are betting that the shares will resume their downtrend, even though the stock has failed to overcome its 10-week trendline at every turn for the past 5 months. Traders should keep a close eye on this moving average, as another rejection here could disillusion many bullish investors, thus creating a wave of selling pressure.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.