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Old Standbys Find New Life in No-Nukes Frenzy

Richard Croft
March 23, 2011
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Canada’s reputation as the safest of safe havens was burnished even more last week, as the markets’ giant weighing apparatus decided that Canada’s vast natural resource hinterlands are likely to be worth even more in the future. And the future is always what it’s about in the marketplace.

Far from stifling the commodity rally, the devastating earthquake-borne tsunami in Northern Japan is likely to increase demand for many materials as reconstruction begins – ranging from base metals like copper, lead, aluminum, nickel, tin, and zinc to iron ore, coal, lumber, and forestry products. All of which, of course, are specialties of Canada’s multi-faceted resource sector. That’s on top of already-strong demand from emerging Asia, especially China, where growing urbanization and industrialization has not just suddenly stopped.

Canadian miners are reveling in a once-in-a-generation scenario where the prices that many of their finished products fetch are many, many times their cost of production. You’d be forgiven for bringing out the old saw that these days, owning a producing Canadian mine is like having a license to print money.

While the heat was on all things nuclear last week, including most of all uranium, other sources of energy to fuel power plants suddenly came into sharper focus. These included the old reliables, coal and natural gas, of which Canada has an abundance. And incidentally which two largish Canadian resource companies excel at extracting and selling.

Bold options traders who think that the latest no nukes frenzy in the wake of the Japanese reactor meltdowns is likely to be more than just a flash in the pan might consider bullish positions to leverage further upside in two Canadian resource majors.

Coal producer (among other things) Teck Resources Ltd. (TSX: TCK.B, recent price: $51.60) and natural gas giant (among other things) Canadian Natural Resources Ltd. (TSX: CNQ, recent price: $48.40) are poised to test their 52-week highs as the market’s newfound love affair with coal and natural gas builds steam, so to speak.

With that in mind, option traders might want to look at two bullish strategies; 1) out-of-the-money covered calls, and 2) long calls.

The covered call strategy will appeal to the more conservative investor looking to take advantage of high option premiums. Note the volatility implied by TCK and CNQ options is in the top quartile of all Canadian options.

If you buy into this strategy, look at buying TCK shares and writing the TCK May 54 calls at 2.20. The return if exercised is 9.31% and the return if unhanged is 4.45%. These are two month returns. The sale of the May 54 calls reduces your downside risk to $49.40 per share.

With CNQ, consider buying the stock, writing the CNQ May 50 calls at $1.70. The return if exercised is 6.82%, return if unhanged is 3.64% over two months. The sale of the options reduces your downside risk to $46.70 per share.

The long option strategy will appeal to more aggressive traders, who see more upside potential and are willing to pay a price to participate. The positive to this strategy is the limited risk, in that the most you can lose is the cost of the call.

With TCK.B, look at buying the May 52 calls at $3.10. The CNQ May 48 calls at $2.65 look interesting for more aggressive traders. If you are buying calls be prepared to take half profits if the calls double within the next six weeks.

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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