Upswing in the Agriculturals?

We allude to fertilizer, of course, something that hasn’t been much in the news lately, given all the fuss and bother about European (and other) debt problems overhanging the global financial system. But people must eat, and animals must be fed.

It just so happens that supplies of one staple grain crop are tight at the moment. Corn prices rallied by 12.5% in less than a month on fears of dry weather in South America, primarily Argentina and Brazil. But these prices have eased in recent days, as have prices for other products like wheat and soybeans. But these price declines could be seen as buying opportunities by big importers like China, who could raise their quotas.

That bodes well for agricultural supply companies like Canada’s Potash Corp. of Saskatchewan Inc. (TSX: POT, recent price: $45.80) and Agrium Inc. (TSX: AGU, recent price $79.13), both of which are major suppliers of potash, a key element of fertilizer. Shares of both companies have recently traded below historical valuations. And any sign of revival in agricultural products demand could give share prices a shot of Miracle-Gro.

The challenge is the overwhelming number of global uncertainties that can cause traders to transition from risk on to risk off trades. Such short term moves in the market make it difficult to buy for anything more than a short term move on the underlying stocks.

Another complicating factor is that premiums on agricultural stocks tend to be at the upper end of all premiums in the Canadian market. Which for me, makes option writing strategies the favored way to play this trade. From a bullish perspective the two option writing strategies that you could look at are covered call writing or naked put writing. Depending on which side of the fence you are sitting.

If you own the shares or are looking to trade the position inside registered accounts then covered call writing is the only option… i.e. buying the underlying stock and writing a covered call against the shares. In the case of POT, consider buying the shares and writing the April 48 calls at 2.30. The four- month return if exercised is 10.3% and the return if unchanged is 5.3%.

Same storey with AGU, where you would buy the shares and write the April 84 calls. The four-month return if exercised is 9.98% while the return if unchanged is 3.6%.

The naked put story follow the same logic, only you are committing to buy the shares at the strike price of the short put. With POT, for example, write the POT April 46 puts at $3.45. If you buy the shares your net cost is $42.55. If the stock is above $46 per share at the April expiration the put will expire worthless.

With AGU, write the April 80 put for $5.25. If the put is assigned, your net cost to buy the share is $74.75. If the stock is above $80 at the April expiration the put will expire worthless.