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Option Tip – Saturday, November 05, 2011
Newmont Mining Call Butterfly Spread



The Option Tip is based around the following quote by Marguerite Blessington

“Genius is the gold in the mine; talent is the miner who works and brings it out.”

Newmont Mining Corp., and founder William Boyce Thompson, certainly fits this category!



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Newmont Mining

Newmont for Investing Gold

The recent recovery in gold prices hasn’t been isolated to the commodity itself. Gold mining stocks have also seen an influx of buying, with many breaking above key resistance levels to continue their longer-term up-trends.

One of the miners that look particularly ripe for the picking is Newmont Mining Corp. (NYSE: NEM). With implied volatility currently nestled in the middle of the six-month range, and trading right in line with historical volatility, option prices seem neither a steal nor overly expensive.

gold prospector

Company Profile

Newmont Mining Corporation acquires, explores, and develops mineral properties. The Company produces gold from operations in the United States, Australia, Peru, Indonesia, Ghana, Canada, New Zealand and Mexico. Newmont also mines and processes copper in Indonesia.

Newmont Mining Corporation (NYSE: NEM, TSX: NMC), based in Denver, Colorado, USA, is one of the world's largest producers of gold, with active mines in Nevada, Indonesia, Australia, New Zealand, Ghana and Peru. Holdings include Santa Fe Gold, Battle Mountain Gold, Normandy Mining, Franco-Nevada Corp and Fronteer Gold. Newmont also has many joint venture relationships.

As of December 31, 2010, Newmont produced approximately 5.4 million equity ounces of gold annually and held proven and probable reserves of about 93.5 million. Newmont employs approximately 34,000 employees and contractors worldwide. Other metals that the company mines include copper and silver.

video of NEM

Founded in 1916 by William Boyce Thompson as a diversified holding company, today Newmont remains the only gold company in the Standard & Poor's 500 Index.



Reasoning for the Option Tip

NEM trades on the NYSE, and closed Friday at 69.38 per share, near the upper end of its 52-week range of $71.25 to $50.05. NEM stock has been showing support around $65.42 and resistance in the $68.58 range. The stock’s 50-day moving average is $64.44 and its 200-day moving average is $58.55.

110711-NEM-graph



Its market capitalization is roughly $41 billion, and it trades at a current P/E ratio of 15. Technical indicators for the stock are Bullish and S&P gives Newmont Mining (NEM) a positive 4 STARS (out of 5) buy rating.

NEM also reported a fine third quarter, though a step below its peers. Its net income increased 19% from the year ago quarter, to $635 million, or $1.29 per share. Its profit margin is about 22%, and its return on equity is 19.6%.

Option Interest

There is a high put/call ratio on NEM, which indicates a bullish stance.

110711-NEM-options



Analysts Reactions to Support the Option Tip

Equities research analysts at RBC Capital (NYSE: RY) lowered their price target on shares of Newmont Mining from $87.00 to $82.00 in a research issued note to investors on Tuesday. They currently have a “sector perform” rating on the company’s shares.

110711-NEM-analysts

Separately, analysts at CIBC downgraded shares of Newmont Mining from a “sector perform” rating to an “underperform” rating in a research note to investors on Monday.

However, other analysts from TD Newcrest, initiated coverage on shares of Newmont Mining in a research note to investors on Tuesday, October 25th. They set a “buy” rating and a $85.00 price target on the stock. Also, analysts at HSBC (NYSE: HBC) raised their price target on shares of Newmont Mining from $92.00 to $116.00 in a research note to investors on Friday, September 16th. They now have an “overweight” rating on the stock.

The Option Tip Strategy

First, let’s look at the typical behavior of gold miners. The price action tends to be a bit more erratic, which increases the odds of shorter-term aggressive traders getting whipsawed out of their trades.

The answer in this situation may lie in entering a cheaper spread trade that doesn’t require too much micromanaging – the

call butterfly spread.

butterfly spread

(If you aren’t able to do butterflies in your account or you’re looking for a simpler strategy, other alternatives are given below.)

Conventional butterflies are taught as neutral trades, but can be structured with more of a directional tilt by modifying the strike prices involved. The basic structure of a long butterfly is to sell the “body” and buy the “wings.”

The trade has a structure of 1 x 2 x 1. The body of the fly should be centered at whatever your target price is for the stock.

The Option Tip

In the case of NEM, let’s say we think the stock is likely to reach $75 by December expiration. So we’re going to center the fly at $75 by selling two NEM Dec 75 Call options.

To complete the position we now need to buy the wings – a call option with a strike below the body and one above the body. Let’s buy the NEM Dec 70 Call and the NEM Dec 80 Call.

To finalize the option tip, we’re “buying to open” one Dec 70 Call (currently trading for $2.70) and one Dec 80 Call (currently trading for 35 cents) – that’s a $3.05 debit so far. Meanwhile, we’re “selling to open” two Dec 75 Calls (currently trading at $1.05 each, or a $2.10 total credit on this part of the trade). The maximum risk is limited to the initial debit and the maximum reward is limited to the distance between the strikes minus the initial debit.

Since the NEM fly outlined above is a $5 spread and can be purchased for around 95 cents ($3.05 debit – $2.10 credit), the maximum risk is limited to $95 and the maximum reward is $405.

Structured in this manner, we will gain our maximum profit if NEM is sitting right at $75 at December expiration. If it remains below $70 or rises all the way above $80 by December options expiration we will incur the maximum loss of $95.

Alternative Option Plays

1. An alternative option tip would be buying the NEM Dec 70-75 bull-call spread outright (i.e., buying the $70 Calls for $2.70 and selling the $75s for $1.05, for a $1.65 net debit). The cost is a bit higher and it therefore has more risk than the fly, but I like the call spread better than buying a call outright.

2. For a hedged play on NEM, look at the Jan '12 $65.00 covered call for a net debit in the $61.63 area. That is also the break-even stock price for this trade. This covered call has a duration of 81 days, provides 7.78% downside protection and an assigned return rate of 5.47% for an annualized return rate of 24.64% (for comparison purposes only).

3. Another option tip which has a lower-cost hedged play for NEM would be to use a longer term call option in place of the covered call stock purchase. To use this strategy look at going long the Newmont Mining Jan '13 $40.00 call and selling the Jan '12 $65.00 call for a total debit of $22.80. The trade has a lifespan of 81 days and would provide 6.03% downside protection and an assigned return rate of 9.65% for an annualized return rate of 43% (for comparison purposes only).


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