After breaking out of a cup-with-handle base on Jan. 5, shares of mining stock Southern Copper soared, reaching a 20% profit target less than two weeks later.
Positive catalysts included a Chinese reopening (the country consumes half of the world's copper), a weakening U.S. dollar and increased optimism among many pundits of a soft landing in the economy.
After this quick run, and with shares up over 21% since the start of January, the stock certainly looks extended. For investors who think that a sharp turn in positive sentiment is a possibility, buying a put option could certainly pay off.
Mining Stock Put Option
With Southern Copper trading at 74.80 at the close on Thursday, investors could consider buying a 70 put option with a March 17 expiry. This option had a cost of $1.85, which equates to a maximum loss of $185 in the event Southern Copper trades above 70 on expiry.
This trade will break even if Southern Copper trades at 68.15 on expiry, and could earn multiples of the premium in the event of a sharp decline in prices.
March 17's at-the-money options currently have an implied volatility of 34%. While that's in line with the 33% realized volatility over the past 30 days, it is far less than the 40% realized volatility over the past year. Considering Southern Copper has not realized below-30% volatility over a 50-day period in the last two years, these options appear cheap.
U-Turn In Sentiment Could Send Prices Spiraling
While there is certainly no shortage of news justifying the previous move higher, a lot of uncertainty still remains on the effects of a prolonged period of higher interest rates and whether the economy can avoid a deep recession.
If the global economy starts to unravel, copper prices along with Southern Copper will likely suffer. If this occurs, this put option could easily generate outsized returns.
Southern Copper is estimated to report its fourth-quarter earnings on Feb. 1. Analysts expect EPS of 83 cents on revenue of $2.45 billion. If Southern Copper hits the mark, earnings for 2022 will see a decline to $3.14 from an all-time high of $4.39 in 2021. Earnings are currently forecast to stabilize at $3.20 for 2023.
Mining stock Southern Copper is currently trading in a profit zone well above both the 50- and 200-day moving averages. The relative strength line only recently came off all-time highs.
