Opportunity in Nuclear Revival?

“Nuclear” is a dirty word these days. The impact from the Japanese tsunami is still ingrained in our minds. The constant video feeds of smoking ruins, technicians in haz-mat suits, and endless sound bites by “experts,” put the nuclear industry back twenty years.

Surprisingly, despite problems with Japan’s nuclear power industry, Germany may end up being the biggest casualty. The German government caved into demands from the fringe Green Party as the price for supporting Greek bailout plans. Ultimately, the German coalition government announced a complete shutdown of its nuclear power infrastructure.

In fairness, the principals of green energy are sound. Who would not want renewable energy that has minimal effect on the environment? And someday, no doubt we will discover a way to make green energy economically viable. But at the moment, wind and solar technology have not reached a stage where they can reliably replace even a fraction of generating capacity from conventional hydro, fossil, or nuclear sources.

Like it or not, nuclear power still presents the best option as a source for clean, cheap, reliable, and yes, safe, energy. India, China, the U.S., Canada, the U.K., and France are industrial powers that rely extensively on nuclear power to feed their appetite for electric power. A need that will only grow in coming years.

So, while “nukes” may be out of favor at the moment, demand for electrical energy will compel the market to rekindle nuclear plants. And with it, companies that feed and supply raw material to the nuclear power-generating business.

Canada has two major players in this space: uranium miner Cameco Corp. (TSX: CCO, recent price $25,44) and engineering/construction company SNC-Lavalin Group Inc. (TSX: SNC, $58.88).

Cameco produces about 16% of the world’s supply of uranium used in nuclear applications. Its’ main operation is in Saskatchewan, where it has controlling interest in the world’s largest reserves of high-grade uranium.

Cameco shares have fallen off the proverbial cliff in recent months, following the general downturn in commodities, exacerbated by a sentiment-driven “no nukes” hysteria. To the point where Cameco is now trading close to its five-year low!

Traders who see a nuclear power revival might look at taking bullish positions in CCO. A couple of ways to play this; 1) could write (i.e. sell) short to medium term cash secured puts or, 2) buy longer term calls.

The first strategy allows you to take advantage of higher than average premiums on CCO options. At present, CCO at-the-money options are trading at 31% implied volatility, slightly above the average of all Canadian equity options and in line with recent historical volatility (i.e. 32%) patterns for the underlying stock. The point being; there is no distortion between the view from option traders and the actually volatility in the stock. Which is to say, no excess fear that further downside moves are imminent.

With that in mind, you could look at writing CCO August 25 puts at $1.00 per share. If the stock is trading above $25 at the August expiration, the options will expire worthless and you will retain the entire premium. Assuming you set aside $2,500 in capital to secure the obligation of the short put, the seven week return would be 4.2%. And for that to happen, the stock could simply remain where it is.

The other approach is to buy longer term calls. Again, because the premiums on CCO are just slightly above the average for all Canadian equity options, you are not paying an exorbitant cost for the calls. Look at buying the CCO Oct 26 calls at $1.60 per share.

SNC-Lavalin is one of the world’s largest engineering, construction, and infrastructure companies. In fact, it just got bigger last week, when its’ CANDU Energy nuclear reactor division acquired the Atomic Energy Commission of Canada’s (AECC) commercial reactor division. CANDU reactors are regarded as best in class, and are used extensively around the world.

Like all companies in the nuclear space, SNC-Lavalin has suffered in recent months. Although it did get a boost last week from the AECC acquisition, it remains well off its 52-week highs. If you are buying into the nuclear story, the stock has upside.

SNC options are trading at implied volatilities in the 24% range, which to my mind, makes call buying the strategy of choice. You might look at the SNC Dec 62 calls (Implied volatility 20.1%) trading at $2.00 per share.