FCX Vertical Credit Spread Op

02/27/09 01:01:19 PM

by Donald W. Pendergast, Jr.

After staging a recovery rally, FCX appears to have stalled and begun to roll over. Here's a possible option credit spread designed to take advantage of this stock's current weakness.

Security: FCX
Position: Sell

Here we go again -- down in the broad market indexes and also in most of the industry groups that populate them. The basic material sector is weakening rapidly, particularly the shares of those companies engaged in copper mining. Freeport-McMoran, based in Arizona, is one of the giants in the copper mining group, and today's price action may be warning of a continuation of the current weakness.

FIGURE 1: FCX, DAILY. Negative RMO and money flow divergences, combined with high option premiums, may offer nimble traders the opportunity to profit in this situation.

Graphic provided by: MetaStock.

When the broad markets tank in unison, it is said that 80% to 90% of all industry groups will also decline in sympathy, no matter the current technical and/or fundamental status of such groups may be. When these kinds of selloffs begin to gather steam, long positions begin to liquidate, put option premiums become inflated, and fear and anxiety begin to overshadow rational thought. While FCX's long-term fundamentals appear to be sound, that isn't much comfort to those who recently bought in near $30, thinking the worst of the vicious bear market was already behind them. Freeport's daily chart may help shed a little more light on what's going on, and more important, how to set up a potentially profitable short-term option credit spread. See Figure 1.

While nothing here suggests a major selloff is imminent, the overall bias is down for the time being. At the top of the chart a bearish hidden divergence has printed on the Rahul Mohindar (RMO) indicator, one of the more accurate momentum-based tools available. A bearish hidden divergence works like this. If the current swing fails to meet or exceed the price level of a prior significant swing but the RMO (or moving average convergence/divergence [MACD]) rises to a higher level than that attained on the prior significant swing, the trend is now presumed to be down. That's the current situation here with FCX's daily graph. In addition, there is a mild negative divergence between price and the Chaikin money flow (34), another potentially bearish warning sign.

Price action, above all, is the primary concern of every trader, and today's wide-range breakdown through the flat 50-day exponential moving average (EMA) is another bearish omen. There is support below near $24.70, $24.22, and then $21.16, of the three levels the first one (the rising red uptrend line) being the most important level, as many traders will be watching to see if this uptrend line will form another pivot (#3), sending prices back up again. The trade I'll describe is designed to put the generally bearish posture of these technicals to good use, allowing a nimble trader to collect premium upfront while FCX (and the broad market) attempts to sort out their next moves.

At present, option volatilities in FCX are well above average, meaning that under the right technical scenario, selling option premium can be advantageous. Since there is a nice resistance level near $30, one possible trade setup to consider is the sale of a March 2009 $30/35 bear call spread for approximately a $0.95 credit. As long as FCX remains below $30 at option expiration, the entire spread will expire worthless. With only 24 days until March expiration, time decay has already begun to work its magic, as progressively larger percentages of the remaining time value are consumed with every passing trade session. (The final two weeks before expiration is when time decay really accelerates at an exponential rate, a wonder to behold). So here's the trade plan: collect at least $0.95 in credit for the sale of the spread and simply hold it for as long as the blue dashed upper channel line continues to contain FCX's price action. If the line is violated on a daily close (or if the spread increases in value by 80%), simply buy back the spread, closing it out.

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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FCX Vertical Credit Spread Op

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