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Commodity Company Could Boost Investors Bottom Line

Commodity Company Could Boost Investors Bottom Line

Commodities are among the oldest markets in the world. There is some evidence grain markets existed 5,000 years ago and that is understandable. Grains are one of the most important products for societies forming cities.

Some grain companies are also among the oldest in the world.

Bunge (NYSE: BG) ranks among the largest global dealers in soybeans, wheat and corn, buying crops from farmers, trading them in bulk to livestock operations and food companies, and making products such as vegetable oil and flour.

The 200-year-old company boasts one of the most extensive agricultural logistics and processing networks in Latin America, which has emerged as one of the world’s biggest crop-producing regions.

But a five-year period of low crop prices and high global supplies have challenged grain companies such as Bunge, forcing cost cuts and spurring consolidation talks.

Looking For Value

After an extended period of low shareholder returns, the company is looking to deliver value.

BG weekly chart

Reuters reported, Bunge Ltd said it will add four directors to its board and create a strategic review committee to explore options for the global grains trader, including a sale of the company, bowing to pressure from activist investors D.E. Shaw and Continental Grain Co.

The company also reported a stronger-than-expected third-quarter profit but lowered its 2018 earnings outlook by $100 million to $1.2 billion with cuts to guidance in two of its four business segments.

But, that wasn’t news for investors who sold the news.

BG daily chart

Selling was driven by management’s lower outlook and fears of future earnings volatility hammered the stock, even as the broader market rose.

J.P. Morgan cut its price target for the company by $5 to $70 a share, citing possible earnings volatility in the coming quarters amid an ongoing U.S.-China trade war, according to analyst Ann Duignan.

The board expansion comes  after the company has fielded unsuccessful takeover bids by rival Archer Daniels Midland Co and commodities trader Glencore, while a prolonged global grain glut has hurt crop prices.

“The strategic review committee formed by the board still leaves the door open for a possible sale of the company, but it also leaves the door open to sales of only portions of the company to give it a narrower focus,” said Christopher Muir, equity analyst at CFRA Research.

Bunge also said it would form a separate committee to conduct a “strategic review focused on enhancing long-term shareholder value.” The six-member strategic review committee will include the new directors named on Wednesday and three current directors, the company said.

“This committee has been created as a good check on what it is we’ve been doing, whether we can do additional things, whether we can accelerate things … There’s no preconceived notions of either direction or topic,” Bunge CEO Soren Schroder told Reuters.

Looking Ahead

Bunge held its 2018 agribusiness segment earnings outlook unchanged in the upper half of an $800 million to $1 billion range, supported by oilseeds operations in the Northern Hemisphere. Fertilizer segment guidance was raised by $10 million tom $35 million.

But the company cut its food and ingredients unit guidance by $40 million to a range from $250 million to $270 million and forecast a $20 million to $40 million loss in sugar and bioenergy, from a previously stated break-even outlook.

This is a cause for concern and could be the key to trading the stock in the short run.

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.

bear call spread

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.

A Bear Call Spread in BG

For BG, we could sell a November 16 $62.50 call for about $6.05 and buy a November 16 $65 call for about $4. This trade generates a credit of $2.05, 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 $205. The credit received when the trade is opened, $205 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $45. 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 ($205).

This trade offers a potential return of about 455% of the amount risked for a holding period that is about five weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if BG is below $62.50 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 $45 for this trade in BG.

These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.