Prices for agriculture commodities such as corn, wheat and soy have been climbing sharply over the past several weeks.
The chart of PowerShares DB Agriculture (NYSE: DBA) helps illustrate the magnitude of this price spike.
Higher agriculture prices have a tendency to juice fertilizer prices. While challenging weather conditions and increased risk remain, I expect global demand for fertilizer to be robust as farmers use it to boost yields.
Shares of Potash Corp. of Saskatchewan (NYSE: POT) look particularly attractive, not only because of the rising demand for fertilizer, but also because of political events that could result in a much better pricing environment for potash fertilizer.
Leading up to last July, there was an established cartel agreement between Russian Uralkali, the world's largest potash producer, and Belaruskali, a producer in Belarus. A disagreement between the two parties led to a breakup of the cartel, and as a result, the price of potash dropped from $400 per ton to a recent $305.
Lower selling prices obviously cut into profits, and POT dropped sharply after the announcement. Nearly a year after the cartel broke up, however, there is speculation of a reunion. If this were to happen, it could boost prices of potash at a time when global demand for fertilizer is increasing. This would be very bullish for shares of POT as profit margins would likely widen substantially.
At this point, it appears that there is significant potential for POT to trade higher based on improving demand for fertilizer and the potential for a reunion of the potash cartel. On the other hand, the chances of potash prices dropping are very small given the fact that most of the negative effect of the cartel breakup is already priced in.
Today, we can take advantage of this with a put-selling strategy. Specifically, I would like to sell the POT April 35 Puts, which are priced near $1.25 per share. By selling these puts, we obligate ourselves to buy shares of POT at the $35 strike price, assuming the stock stays below this level through April expiration.
If POT moves just a bit higher from here, the puts will not be exercised and we will be able to keep our $1.25 per share ($125 per contract) that we received from selling the puts.
However, if POT remains stable, we will be obligated to purchase shares at a net cost of $33.75 ($35 strike price minus the $1.25 premium). I would be happy to pick up shares of POT at this price given the strong global demand for fertilizer and the potential for a significant price jump if the cartel were to be reinstated.
Given that we will need to set aside $33.75 per share ($3,375 per contract) of our original capital in the event that we are obligated to buy the stock, the $1.25 in option premium represents 3.7% in income over the capital we are allocating for this trade. The puts expire in 30 days, so our per-year rate of return is actually closer to 45%.
Action to Take --> The situation for fertilizer stocks looks very attractive right now, despite the broad overall risks in the market. And for POT in particular, there are additional political issues that could prove to be a tailwind. An annualized return of 45% looks very attractive given the overall environment for this stock.
This article was originally published at ProfitableTrading.com:
I Love the Risk/Reward in This 45% Per-Year Income Opportunity