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Trader's Radar: A Dirty Mining Call in Peabody Energy

By Chris Tyler, Optionetics.com | Fri March 30, 2012 1:35PM PT

“Coal”, it’s a dirty subject these days and in more than one way for shareholders in names like Alpha Natural Resources (ANR), Alliance Resource (ARLP), Arch Coal (ACI) and Patriot (PCX). While bulls have been giddy as schoolgirls for commoditized consumer goodies like Apple (AAPL) with gains of 50% since the start of 2012 and the SP-500’s (SPY) tasty 11%, the coal group has been mining its way to unhealthy year-to-date losses. In fact, all of those companies are now testing those nearly forgotten November 2008 lows which were a precursor to the market’s own March 2009 bottom. And conditions may have just gotten worse.

In the wake of an unusually warm and hurtful winter to coal producer’s bottom-lines and one also finding increased competition from cheaper and cleaner natural gas, a bag of ‘you know what’ was delivered on Tuesday by the EPA. The government agency proposed its first-ever standards to reduce carbon dioxide emissions from new power plants. Not only will this quash the building of new facilities, but the signing of longer-term contracts and a further squeeze on margins is likely to ensue.  Is it the proverbial end for the group and one which extends beyond the end of quarter theatrics on display this week most everywhere else in the market?

Our view is it certainly sounds like suffocating bulls are going to have a difficult time digging out. But at the same time, we can’t help but play devil’s advocate and see bulls’ well-worn headlamps able to point their way out towards a recovery in a “buy the news” contrarian situation. In an effort to make a bit more sense and perhaps cents in this type of forecast, we’d draw prospective bulls’ attention towards Peabody Energy (BTU).

Peabody is best in breed on a couple important fronts which sets it apart from its industry competition. From a technical perspective, BTU is the only company whose ticker remains positioned still well above its November 2008 low of $16 a share despite shedding nearly 60% over the past year and 14% in 2012.

Figure 1: Peabody (BTU) Monthly Digging Pattern

Given the sizable loss in shareholder value, it may not sound like much to be outperforming one’s peers based on one key and very agitated price level. Optimistically though and a fundamental driver not accessed by the others in its group, the price action could reflect the world’s largest coal outfit’s still diminutive global presence of just 2% but one which stands to benefit from increased demand by energy-thirsty China and India despite difficulties in doing business as usual here in the US.

Figure 2: Peabody (BTU) IV History

Looking at BTU’s options for ideas, we see longer-term September or January out-of-the-money calls as premium that appears interesting for purchase. Part of that determination is implied volatility looks like it may be bottoming as shown in Figure 2. Secondly, lighter delta, further-out positions are in keeping with an intermediate view that shares can stage a rebound if given enough time. Finally, we’ll admit we’re optimistic the start of a new quarter could mean investors might want to play a game favoring down and out commodity plays other than one very green Apple. Net, net the dirty business of mining as a bull in coal looks a bit greener going into Q2, than otherwise.


Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
Optionetics.com ~ Your Options Education Site
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The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual. 


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