Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Money Trafficking,

Think Call Spreads In AngloGold This Monday

AngloGold Ashanti Limited (AU) is a gold mining company. The company's business activities span the spectrum of the mining value chain. Its main product is gold. Its portfolio includes over 17 mines in approximately nine countries. It also produces silver, uranium and sulfuric acid as by-products. The company operates through four segments: South Africa, Continental Africa, Australasia and Americas. It is reporting earnings on Monday, August 15, after market close:

As evident from the above, the company beat earnings estimates in 50% of time in the last two years or so, underperforming in the rest of time, and has seen modest volatility and a strong positive trend in the market price of its stock over the last three months:

Market data show that the August options are a undervalued:

(Source: TD Waterhouse)

The one-week straddles (options with a strike price of $22.00 and expiring on August 19, 2016) are worth around 6.3% of the current market price of the stock. Historically, the stock has been more volatile than that on a monthly basis over the last year:

(Source: Google Finance. Calculations by author)

As you can see, the stock has had a monthly standard deviation of 19.2% over the last 52 weeks, while the straddle expiring in a less than two weeks has an implied monthly volatility of around 10.3% (calculated based on 6 business days remaining until expiration), also including volatility from the earnings event next week. I therefore see signs of undervaluation in these options. Hence, buying the straddles is a good idea from a theoretical standpoint.

Investors may also be interested in buying call spreads to lower the cost basis of the trade:

(Source: optionsprofitcalculator.com)

On the one hand, this will limit expected returns. On the other hand, this action will minimize losses in the event the stock does not move swiftly over the next week. The risk-return profile of this trade looks like this:

(Source: optionsprofitcalculator.com)

As you can see from the above illustration, the break-even price is around $22.40. This means that the stock has to move roughly 1% upwards from the current price by expiration in order for investors to break-even. The risk-reward ratio of around 1:1.50 is below-average for this type of option strategies.