Interested in a potential 50% Return on Teck Resources?

Before we get into the juicy numbers of the options trade, it is important to put some perspective on Teck Resources and where it is at. Teck Resources is one of Canada’s premier basic material stocks. The company has global operations in copper, coal, zinc, lead, molybdenum, gold, silver and various chemicals/fertilizers. The recent drop, (more like crash) in commodity prices has challenged its growth and earnings, driving the stock to lose close to 50% of its market value over the last 3 months.

Ouch to say the least. Here are the current facts:

• Though there has been a contraction of earnings, the company is currently still profitable
• The company pays a nice dividend, but with a 152% payout ratio (source: yahoo finance), implies that the dividend is at risk of being reduced or cut all together
• From its $20.58 February high, TCK.B has materially dropped, hitting a $8.77 low in July

With the full understanding that the stock is now pricing in an array of risks, an investor willing to undertake those risks has an interesting income opportunity using a long-term covered call.

Covered Call Strategy:

The Covered Call Strategy involves buying (or owning) the shares of a stock and selling (to open) a call option against the stock. A short call generates an income (equivalent to the option’s premium received) with the obligation that the investor must potentially sell the stock at the strike price throughout the life of the option, if he or she is assigned.

Here is an example of the strategy, with an investor buying 1000 shares:

• Buy 1000 shares of TCK.B ($9.35 on July 30^th 2015) or $9,350.00
• Sell (to open) the long-term January 2018 $9.00 covered call (bidding $3.35 July 30^th 2015) or $3,350 credit
• The investor has to outlay $6.00 ($9.35 – $3.35) or $6,000 to open the trade
• The investor has now an average cost base or break-even of $6.00 with an obligation to potentially have to sell the stock at $9.00 over the next 30 months to January 2018
• In addition, over those 30 months the investor will collect any dividends the company continues to pay

What is compelling about this trade is that the investor can make 50% return without the stock having to actually go up in price. How? Let’s review.

Our investor has outlaid $6,000.00 that, if exercised would be sold at the $9.00 strike or $9,000.00 for a $3,000.00 gain. While 30 months is a long time, how many investors would consider gaining this type of return without needing a stock to appreciate in value?

In all fairness, let’s present the risk scenario. For the illustration purposes, let’s assume that the commodity markets continue to deteriorate and Teck Resources loses a further 50% of its value and drops from $9.35 to $4.67 while our investor owns the shares. Under those circumstances, the investor is losing paper profits as the stock has dropped $1.33 (or 22%) below their $6.00 break-even. While that would be a disappointment, it is not remotely as severe a loss as an investor that purchased the shares outright at $9.35 and held as a buy and hold investor.

While this trade may represent too much risk for some, others that like the company and believe the prices at these levels are attractive can make a very handsome return if proven right.