Technically Challenged Cameco Yields Option Opportunity

11/25/08 10:34:56 AM

by Donald W. Pendergast, Jr.

After an 80% plunge in five months, Cameco's inflated option premiums may offer creative profit opportunities for traders and investors.

Security: CCJ
Position: Accumulate

After dropping to single-digit prices, uranium, an indispensable energy commodity, had become so unprofitable to mine that existing mining operations had crawled to a near-standstill by the early to mid-1990s. That caused an ever-increasing gap between increased global demand and existing mine and above-ground stockpiles, precipitating one of the most powerful commodity bull runs in modern history. From the January 2001 low of $7 a pound, prices for uranium rapidly accelerated throughout the mid-2000s, finally peaking out near $140 a pound in June 2007. Cameco was one of the equities that tagged along for the ride skyward; the stock outperformed uranium ore by a few percentage points, gaining more than 2,100% during the same 6-1/2 year period. Like every commodity run (bubble?), severe corrections against the primary trend always occur, usually commencing at the point of mass investor euphoria. Whether or not Cameco's correction is temporary, or if it has begun a long-term bear market, this much is clear -- long-term global demand for uranium ore is progressively outstripping the current level of supply.

FIGURE 1: CCJ, WEEKLY. Extremes in both historical and option implied volatility can offer traders a variety of unique profit opportunities.

Graphic provided by: Ensign Windows.

The weekly chart of CCJ is similar to many other commodity-linked equities -- it displays a massive, relentless selloff that only now shows any sign at all of abating (Figure 1). The Fibonacci 78.6% retracement has been slightly violated, but given that another major support level lies just below the $10 mark and that the detrend oscillator is rising from a record low, even as it manifests signs of bullish price-momentum divergence, it appears that Cameco has indeed hit a major speed bump that has reduced its downside momentum. If the broad markets follow through with a reaction rally higher, Cameco should also go along for the ride, given its (one-year) 0.89 correlation with the Standard & Poor's 500.

FIGURE 2: CCJ, PUTS. The Cameco January 2010 $7.50 put option has a 43% chance of expiring in the money, based on current option IV.

Graphic provided by: Option Wizard Online.

Despite the overall bearish posture of the chart, for long-term uranium bulls, Cameco's inflated levels of both statistical and implied options volatility may offer traders the ability to construct option trades that take advantage of extremely high option premiums. Historical weekly volatility (HV) comes in at 174%, even as implied option volatility (IV) is also near the top of its two-year range. A longer-term trader, one who believes Cameco will eventually recover, might consider selling January 2010 $7.50 put options for approximately $1.60. If assigned at expiration, his/her basis in the stock is reduced all the way down to $5.90 a share, a 55% discount from current prices.

If the stock rallies and/or IV reverts to its mean, short- term traders could simply buy back the puts for a fraction of the premium collected and then put their margin to work in other opportunities.
Meanwhile, CCJ's fundamentals appear to be sound; the stock pays a 2% dividend (raised four times in the past five years), the forward P/E is 9.98, and earnings per share (EPS) comes in at 1.11. Cameco also produces 19% of all global uranium supply from its various Canadian and US mining facilities.

Plotting historical volatility on your charts allows you to be aware of the general level of current options premiums and whether they're high or low on a relative basis. Once you locate extremes in HV, you can then investigate option IVs and other vital option data such as the bid-ask spread, available strikes, probability of expiring worthless, liquidity, open interest, and time decay.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
	Jacksonville, FL 32217
Phone # for sales:	904-239-9564
E-mail address:	lineartradingsys@gmail.com
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Technically Challenged Cameco Yields Option Opportunity

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