Fertilizing Profits

Going against the grain, so to speak, of most commodities these days are two Canadian agricultural stocks. While energy and metals and mining issues mostly got clobbered in the early January commodity downturn, Potash Corp. of Saskatchewan Inc. (TSX: POT, recent price $165,82) and Agrium Inc. (TSX: AGU, recent price $91.38) did not.

That’s because these two fertilizer stocks are very big in the global food chain. And that chain is once again under pressure from price inflation and shortage scares. The United Nations Food and Agriculture Organization’s food price index climbed to 214.7 in December, higher than the previous panic-peak of 213.5 in June 2008. Back then, high prices and temporary shortages led to food riots in many Third World nations, and even in some advanced countries, where high wheat prices led to shortages of pasta.

This time around, poor weather in many exporting areas has crimped harvests, especially corn and soybeans. Drought in Russia curtailed wheat exports this year. Floods in Australia have hit sugar exports. And the effect of La Niña off Pacific South America is expected to reduce South American crop yields, including wheat, corn, and soybeans.

Higher prices, of course, result in more planted acreage in the next market year as farmers shift crops to take advantage of higher prices. And that means more demand for fertilizer. And that’s where Potash and Agrium and other agricultural stocks come in.

For bold options traders, this could present an interesting and potentially profitable play. If you believe that the unfolding food-price story is not yet completely baked into the market, then companies like Potash and Agrium could still see more price momentum. If so, bullish options position now could pay off leveraging further sentiment driven gains in these two stocks.

There are two strategies to look at; 1) covered call writing or naked put writing and 2) buying calls. At the moment that latter strategy looks more appealing because the cost (i.e. implied volatility) of Agrium and Potash options are at the lower end of their range.

With Agrium look at buying the AGU April 92 calls at $5.80 (implied volatility 31.6%). As for Potash, consider the April 170 calls at $9.50 (implied volatility 32.6%).