Molycorp Options Money with Calls Early and Now Puts page 1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Jan 17, 2011  (Chart of Option prices of recent IPO with lock up expiration)

Molycorp is an example of how one can make profitable trades with options going long on the calls and puts. In December I went long the Jan 30 calls, but quickly sold after a 40% profit in a couple of days. By booking this quick profit, I missed out on $29 profit per call contract which I am still kicking myself over.  I was turned off by the less than stellar fundamentals. Later I went long the Jan 50 puts and closed the profitable position prior to the long holiday MLK weekend.  Had the market been open on Monday, January 17th, I would have most likely rolled the position to February 50 puts.

I was anxious about the long holiday weekend simply from the point of time decay and I noticed some large lots of call buying at the offer in the Jan 50 and 55 calls on Friday.  Logic tells me that a significant event with the company couldn't be forthcoming due to the pending lockup expiration later this month.

First a little bit on Molycorp.  It is a highflying mining stock of the so called rare earth metals. It has been a hot topic on all the financial news channels and a hot topic of stock chat rooms.

It is interesting to note that the light rare earths are less valuable than the heavy rare earths.  23% of Avalon's (AVL) deposits consists of the heavy rare earths where REE and MCP have 1% of their deposits in the heavies.

The stocks in this sector saw a dramatic increase in their stock price when China, the world's dominant producer (supplies over 95% of the global demand) of the rare earths said it would curtail exports for the first half of 2011.  I didn't see anything where it would reduce production domestically, so my take is they want to see an increase in the raw product price and produce products using this material within their borders.

As most readers know, the rare earths are really not all that rare.  Conservative estimates place reserve estimates of 800 years based on near term consumption rates. It is important to note these elements are difficult (read: expensive) to extract from the ground.

My thesis is that MCP should go down in price at least in the short term due to:

Molycorp is still a money loser and is at least 18 months out from full production if all goes well..  As more miners come online, the elevated supply should be a catalyst for lower prices.  More supply leads to lower price.

In late 2010, Molycorp's CEO said that at $30.00, the stock was a bubble.  A few days later he tried to take back that statement by saying that he misspoke. He is motivated to keep the stock price up since the lock up period is looming -- more on that below.

In early January of 2011, MCP's market cap of $5 billion was more than three times the entire sales in this space of 2010.  They are not the only producer and certainly not the first producer. What happens if China comes out with notification of an increase in exports? Not saying it will happen or that it won't, but it is a possibility.  They could cave in to international pressure and then where will the rare earth miners find themselves.

China has recently noted the environmental impact of mining the rare earth elements.  They had to recently relocate villages because of carcinogens found in the nearby water supply.  Molycorp's Mountain Pass mine is located in California and I suspect that at least one environmentalist group will pick up on that soon.  It is possible that an environmental group could delay production until there are further studies.  

If all these producers come online of which Australian company Lynas will be able to extract first to start mining the rare earths, then we should see a plunge in the raw material. MCP hopes to be operational in full force by 2013.  Other companies like REE will be online, if at all, by 2015.

MCP saw a huge appreciation in price when there were rumors that they would be extracting in early 2011.  After news came out that it would not be able to extract anything from the mine until late 2012 if all went well, the share price went down and then went on to recover and appreciate once again.

An analyst from Dahlman Rose issued a price target of $85 a share on MCP.  I found this suspect since Dahlman Rose was a co-underwriter of Molycorp's IPO. This seems like a serious conflict of interest and at best a desperate attempt to keep the stock price inflated until the lockup expiration.  There seems to be some

There was also a story on January 13, 2011 that MCP would seek loan guarnatees from the government for mining.  I suspect the US government would say why come to us when they could issue a secondary.  I would also think the government would ask or at least be curious about what MCP did with the first batch of money from the IPO. For some reason this loan guarantee seeking effort was seen as a positive, but I don't see how a newly public company asking for a bailout is a good thing. The only reason I can see for contemplating the request is that certain rare earths are used by the Defense Department and MCP would cite the scaling back of these materials as an issue of national security.  

There is also recent evidence that large consumers of the rare earths would be scaling back their need for these elements: On January 14, news came out that Toyota a big user of the rare earths, was implementing alternatives to these materials for their cars since they were unable to convince China to increase their exports -- at least to them.  Toyota uses 10 pounds of the rare earths in every Prius.

On January 14, General Electric notified shareholders that it would decrease the use of rare earths in their wind turbines by 80%.  Green energy are heavy users of rare earths. General Electric is a big player with wind turbines.  I would expect the other players to follow GE's lead.

The most compelling item looming over Molycorp's stock price is the lockup expiration from the recent IPO. Most estimates have it at 50 million shares coming to market on that day.  Those shares would flood the market where last week the average trading volume was around 5.5 million shares a day. My research has the day as either January 20, 2011 or January 25, 2011.  Edgar's has it as January 25, 2011.  You can view that information here.

I thought it odd that the week of January 9th we were informed that MCP would release earnings in March 11, 2011.  It was odd because prior to that week, earnings were supposed to be released on January 14.  I suspect it was changed as to not push the lockup expiry further back.

One can look at two recent examples of what has happened recently to stocks on the lockup expiration day -- TSLA and MOTR.

First TSLA, Tesla had a lockup expiration date of December 27th and the last day to trade prior to the expiry was December 23 due to the Christmas holiday.  On the pre lockup trading day, the stock traded as high as $32.48 and on December 27, the stock traded as low as $22.06 which represents a complete crash. It resulted in a decline of 22% from one trading day to the next from high to low.  On January 14, 2011, TSLA closed at $25.75 and never traded higher than $28.71 after the lockup expiration.  This means it never got closer than $3.50 from that penultimate lockup high and is still down almost $7.00 a share from that high on the pre lockup trading day.

How did the TSLA options trade prior to lockup expiration date and on that date?  continued

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