Alexander Valtsev
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Earn A 5% Riskless Return On Barrick Gold's Stock And Options

Barrick Gold’s (ABX) shares rallied today by double digits in tandem with the price of gold, while the rest of the market tumbled, and VIX touched the 17-point level, which trader Jonathan Rose for the market’s recent bullish momentum. According to Motley Fool, the stock’s success over the last three months can be mainly explained by favorable fundamental changes in the company’s capital structure:

Needless to say, with gold prices depressed, Barrick started an aggressive and ambitious plan to slash debt across the board, setting a target of $3 billion, or 25%, of debt reduction by the end of the year. Even more impressive is that the company met that target through a number of sales, partnerships, and deals.

(Source: Motley Fool)

It is true that gold prices have also contributed to the increase in the company’s share price (in fact, this is the major catalyst because it changed the market’s sentiment towards gold prices). However, as you can see in the graph below, the stock has a strong sensitivity to the price of gold and, as a result, has rallied much stronger that the price of gold itself:

(Source: Google Finance)

Note: I used SPDR Gold Trust ETF (GLD) as a proxy for gold’s returns.

The price of the stock has rallied by almost 11% today without any fundamental reasons behind it. As a result, call options have gone to the orbit on extremely high volumes:

(Source: Google Finance)

In addition, both calls and puts have gained in value due to a substantial increase in volatility:

(Source: Google Finance)

One of the best strategies in this situation is to sell volatility, while it is high. Keep in mind that one of the reasons why the volatility has started growing recently is that the last two weeks were filled with earnings releases by major international corporates. Met and unmet analysts’ expectations have tremendously impacted market capitalizations of these companies. In addition, during the last week, the market was waiting for the Fed’s decision on the rates, which has been established by the end of the trading week. Hence, I believe there are reasons for volatility to plateau in the short-term, which is all we care about with options.

While volatility is high, it is a smart idea to sell it by selling straddles. Being net short on volatility is dangerous, which is why I recommend hedging upside exposure by going long in the stock (you can also employ the iron condor strategy but it will not yield a high return because you will be buying expensive options for hedging purposes, as well). Regarding the downside, if you are already long the stock, you are already accepting the possibility of the stock going all the way to zero (even though it is highly unlikely). Alternatively, you can buy some out-of-money puts to hedge the downside, if you are uneasy with the aforementioned risks.

In essence, I recommend doing a covered straddle:

(Source: optionsprofitcalculator.com)

The risk-return profile of the trade is given below:

(Source: optionsprofitcalculator.com)

Note: I recommend selling May 7th straddles (the current market price of the stock is $19.37).

The trade offers the investor a ~7.5% gross return over a one-week period (fees and taxes excluded. The break-even point at expiration is $18.71 per share. A put with a strike of $18.50 (just a few notches lower than the break-even price) costs about $0.30 per share. This means that the net credit balance of the trade, given that you buy the protective puts, is $115 per one straddle (one hundred shares). The minimum profit (assuming the stock tanks below the break-even price next week) with this trade, given the cost of the protective put and the difference between its strike price and the break-even price of the straddle, is $94 per contract. Essentially, this means that that this trade is risk-free.

I am looking forward to Monday to see how the situation on the market for these options will change. If the opportunity persists, I will initiate the trade.

What do you think?