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Covered Calls on Gold Miners

Richard Croft
September 16, 2013
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Most investors think October is the worst month for stocks. Not so! In reality, September inflicts the most pain on portfolios, although this year… not so much! Even lagging Canadian stocks posted a 0.98% gain in September, although that was but a third of the September return south of the border.

So far traders have been focusing on the positives… less parsing of Fed doublespeak, more focus on real fundamentals, where data suggesting a stronger economy might actually be good for stocks! Imagine making calculated investment decisions based on real economic data.

In that light, one might say that the paltry September rally for Canadian stocks under-estimates the promise of growth. Or maybe, the connection is blurred because underperforming gold stocks have weighed down the Canadian market.

The underperformance of gold stocks is not surprising when you consider that gold sits on one end of a teeter totter opposite the US dollar. Now follow the bouncing ball; Fed tapering infers higher US interest rates which causes the US dollar to rally. US dollar up… gold down!

If we employ a calculated investment approach, might this be an interesting time to mint some gold miners as part of a covered call strategy? Especially when gold stocks are down and options on gold stocks are trading in the top implied volatility quartile.

There is a reason why options on gold stocks yield such decent premiums. Gold stocks exhibit higher-than- average intraday volatility, yet often remain locked in an expanded trading range. Range-bound stocks with high intraday volatility make excellent covered call candidates.

Take a look at some of the premier players such as Goldcorp (TSX: G, Fridays’ close $27.35) and Agnico Eagle (AEM, $27.86), both near their 52 week lows.

If you were to buy Goldcorp at $27.35, consider writing the January 28 calls at $2.40. The four month return if exercised is 12.22%, the return if unchanged is 9.62% with a downside breakeven of $24.95.

With AEM, buy the shares and write the December 28 calls at $2.60. The three month return if exercised is 10.85%, the return if unchanged is 10.29% with a downside breakeven of $25.26.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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