I made some options trades last while the pros were on vacation. I use options when I have a specific catalyst for the underlying stock to rerate. Aside from leverage, options also provide a timeline for the trade to either work or not.
Here’s what Nassim Nicholas Taleb writes in Fooled By Randomness:
It is not how likely an event is to happen that matters, it is how much is made when it happens that should be the consideration. How frequent the profit is irrelevant; it is the magnitude of the outcome that counts.
Nassim Nicholas Taleb, Fooled By Randomness
Taleb was referring to rare events with low odds of occurring, but which have huge upsides. But what if rather than trying to be right on rare events, you could profit by being less wrong – and putting less money at risk – on conventional bets? This seems possible since most company-specific outcomes are rarely sudden and binary.
Equinox Gold
All prices in USD
- Bought the Jan 2023 $7.50 calls for $1.70
- Sold the Jan 2023 $7.50 puts for $1.92
- Share price at purchase: $7.04
- 540 days to expiry (at time of purchase)
The thesis here is that in the next 540 days Equinox Gold will fully resolve the disputes that had closed the Los Filos mine and crushed the share price. With those disputes long forgotten, Equinox would rerate based on rising gold prices, rising production and continued M&A.
Even before last week’s press release announcing production had resumed, a resolution at Los Filos seemed likely based on Spanish-language reports.
The price of Equinox was $7.67 on the day the shutdown was announced. Rather than tying up $7 per share with the expectation of selling for $10-$13 after two quarters of steady state production prove the labour disruptions are fully resolved, I bought and sold equal amounts of put and call contracts and netted out with 22 cents per share.
Here are the scenarios at expiry:
- EQX closes above $7.50: I keep my 22 cents and any share price above $7.50 is pure profit.
- EQX closes between $7.50 and $7.28: I break even. The stock is put to me at $7.50 but I have my 22 cents to offset this.
- EQX closes below $7.28: I’m losing money. The goal would be to see this coming and minimize any loss by closing out the trade before expiry.
These are famous last words, but the first scenario is the most likely to occur based on the latest developments not getting factored into the share price, the technical indicators for future gold prices, and Equinox’s projected cash flow based on its margins and production outlook.
I also executed options trades last week for Canadian Natural Resources and Southern Copper, but those are based on my expectations for higher oil and copper prices and are more risky because of that (macro vs. company-specific). Equinox is pricing in a worse case scenario for Los Filos. Any outcome other than that should make this trade very profitable without committing anything other than margin capacity.
