A Two Month Holding Period Could Deliver Income of 184%
A recent fire could add to the woes of a South African chemical and energy company. PR Newswire reported, “Sasol Limited (NYSE: SSL) operates as an integrated chemical and energy company in South Africa. The company operates through Mining, Exploration and Production International, Energy, Base Chemicals, and Performance Chemicals segments.
It operates coal mines; and develops and manages upstream interests in oil and gas exploration and production in Mozambique, South Africa, Australia, Canada, Gabon, and Australia.
The company also markets and sells gas, electricity, and liquid fuels products; and develops, implements, and manages international gas-to-liquids and coal-to-liquids ventures.
On Monday 13 January 2020 at 13:15 (US Central Standard Time), [the company] experienced an explosion and fire at its LCCP low-density polyethylene (LDPE) unit.
The fire was extinguished and all employees and contractors are safe and accounted for.”
LDPE is a thermoplastic made from the monomer ethylene. It was the first grade of polyethylene, produced in 1933 by Imperial Chemical Industries using a high pressure process via free radical polymerization.
Its manufacture employs the same method today. The EPA estimates 5.7% of LDPE (recycling number 4) is recycled. Despite competition from more modern polymers, LDPE continues to be an important plastic grade. In 2013 the worldwide LDPE market reached a volume of about US$33 billion.
LDPE is widely used for manufacturing various containers, dispensing bottles, wash bottles, tubing, plastic parts for computer components, and various molded laboratory equipment. Its most common use is in plastic bags.
The news release highlighted that the fire is another problem at this facility,
“The new LDPE unit had not yet achieved beneficial operation (BO) as planned for in December 2019. The unit was in the final stages of commissioning and startup when the incident occurred. The unit has been shut down and an investigation is underway to determine the cause of the incident, the extent of the damage and resulting impact on the LDPE unit’s BO schedule.
All other Lake Charles units and previously commissioned LCCP units, namely the ethane cracker, ethylene glycol/ethylene oxide and linear low-density polyethylene units, are unaffected and operating to plan.
The ethane cracker has achieved nameplate capacity following the successful replacement of the acetylene reactor catalyst in the plant during December 2019.
The remaining three downstream units under construction to complete the integrated LCCP site, Ziegler alcohols and alumina, alcohol ethoxylates and Guerbet alcohols, are also unaffected and remain within cost and schedule as per our previous guidance.”
The news comes as the stock is in a short-term down trend.
The longer-term chart using weekly data confirms the down trend.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in SSL
For SSL, we could sell a March 20 $17.50 call for about $2.60 and buy a March 20 $20 call for about $0.75. This trade generates a credit of $1.85, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $185. The credit received when the trade is opened, $185 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $65. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($185).
This trade offers a potential return of about 184% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if SSL is below $17.50 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $65 for this trade in SSL.