How to take advantage of miners without being a geologist?

ETC and calls plus events as catalysts

Simplicity beats complexity. Always.

Investing in commodities could be less complex and potentially lucrative or too complicated and potentially lucrative. I prefer the former.

What does it mean?

In investing, it is more important what NOT to do than what to do. The strategy I elaborate on today follows that motto. It saves me from my self being too dumb and adventurous, assuming I can play junior miners without knowing much about geology.

In my opinion, mining small caps are suitable for investors who have deep knowledge in the field. So they can weed the fluff. I am not among those, so I stay on the fence.

Junior miners carry high probabilities of failure. One out of ten projects eventually goes operational. As I mentioned, recognizing the winners in mining takes more than being good with balance sheets. So, due to my inability to pick the right horse, the odds of success are heavily against me.

Yet I like the risk-reward of mining juniors exceeding x10 but dislike that the odds are not skewed in my favor. The solution was to combine direct exposure to the metal to get the Beta (to metal price) and LEAPS calls of the majors to get the Alpha.

Note: I use only long call options. However, LEAPS includes much more than that. For simplicity, in today’s article, I use calls and LEAPS interchangeably.

Wisely selected, the LEAPS calls offer junior miners upside potential with major miners' downside risk. Simply put, I get a risk-reward north of 1:5 with significantly lower odds of being wrong. The chances of Agnico Eagle going bankrupt are way lower than a small producer with one mine in Ghana.

My solution is seeking exposure directly to the commodity in question, plus LEAPS calls on the most liquid companies in the industry.

There are multiple ways to get direct exposure to any commodity. I prefer leveraged ETCs (exchange-traded commodities), which have numerous advantages compared to futures. They work perfectly for bets with a time horizon below one year. Nevertheless, there are factors to consider, like timing, sizing, and position management. A lucrative idea may turn into a disastrous bet, leading to massive losses if neglected. The same applies to LEAPS calls. Always start with risk management, then think about profits.

LEAPS calls requirements:

• Strike price well above present underlying price, i.e., I buy DOTM options, seeking at least 50% upside potential in the underlying price

• Implicit volatility (IV) below 40%; if below 30%, even better. This transforms the underlying upside potential of 50% into LEAPS upside potential of 500% and beyond.

• We need liquidity measured by open interest and volume. In this way, we have a guarantee that we can exist when we reach our targets.

• The time to expiration is at least 12 months. Thus, I give my thesis time to play out.

By buying options, I obtain path dependency immunity in exchange for time and volatility dependency.

Path dependency simply means the route the price takes to reach my target. Basically, there are three options for stock price movement: directly reaching the target, prematurely hitting my stop loss and then moving to the target, or directly going to the stop loss. To avoid the second scenario, I buy LEAPS. In this way, I hire a risk manager to manage my position for a fixed period.

LEAPS call positions are time-dependent, i.e., the option expires after a certain period. To mitigate the time effects on option premium price and increase the odds of being right, I buy calls with at least 12 months until expiration.

I transform volatility into an Alpha booster by choosing calls with low IV. In other words, we profit not just from rising share prices but also from growing volatility. The underlying may move by 40%, while a LEAPS call may move by 400% (if appropriately chosen).

Another reason I like options is that they make me think about time. The arrow of time moves in only one direction: the future becomes the present, and the present becomes the past. Investing in equities makes it easy to forget that fact.

On the other hand, in option strategies, we must first consider time and then risk reward. So, the process starts with a straightforward question: When do I expect the price to reach my target?

And here comes the timing. Remember, a brilliant analysis combined with poor timing fails compared to a good enough analysis and adequate timing. To estimate the time ideally is impossible, i.e., in a matter of days. However, scheduling our position in a few months is entirely possible.

To time the market, we have two options at our disposal:

• Technical analysis in its simplest yet most efficient form: price action on weekly or monthly charts based on horizontal trend lines.

• Catalytic events like corporate actions, a looming deficit of a specific commodity, or geopolitical shock. The former is a company-level catalyst, while the latter two are macro catalysts.

I give two examples, one for macro catalyst and one for company-level catalyst. The first is the uranium shortage. I discovered the uranium story in early 2020. At that stage, the deficit started to be evident. However, it was too early for significant catalytic events. NPPs were at the bottom of popularity; the Green Craze was taking over, and COVID-19 was the new narrative.

A uranium story gained traction in late 2022, so it was time to build a position. I chose the most liquid option, Cameco Corporation. CCJ’s LEAPS calls were selling at an attractive IV below 35%. Moreover, the liquidity was good, plus options expiring in January 2024 were available.

Since then, a few geopolitical shocks happened, like the Niger coup. They acted as a spark that ignited uranium equities. Besides that, the volatility has increased, too. Accordingly, I made a handsome profit from Cameco calls. CCJ stock moved by 50% while CCJ calls by 500% over four month period.

The other example of LEAPS play is Navios Maritime. Navios is not a mining company. However, it serves well as an example to illustrate the power of catalysts combined with LEAPS calls. I found the company in October 2023. The company had (and still has) adequate finances and a massive fleet of tankers, bulkers, and container ships. It was trading at 25% PNAV. The red flag that turned greenish was the management, which was notoriously disinterested in shareholders (and probably still is).  

My bet was on a shift in that attitude. In November/December, I started to build a position with LEAPS calls. They were sold for pennies, measured in implicit volatility. In March 2024, my idea played out. Angeliki Frangou, the company’s CEO, said she started purchasing shares on a personal account and is considering future share repurchase programs. Navios shares made a significant move and my calls moved to DITM. The stock realized about 80% gains, while the calls delivered 500% between November 23 and March 24.

In today‘s article, I discuss commodity plays based on macro-catalytic events. In that context, an award-winning combination is a looming deficit plus geopolitical shock. Uranium is such a case. PGMs, too, fall in that category.

Ideas based on company catalysts exist. Nevertheless, to consider them as asymmetric and actionable, they require macro catalysts, too. If you are curious, see my write-up on the Northern Dynasty.

Cameco and Navios cases illustrate the importance of catalytic events and how powerful they are combined with LEAPS. A kind reminder: LEAPS is not a 100% success rate strategy. Out of 100 bets, about 60-65 go bust, i.e., the option expires without value. However, the remaining 35-40 bets bring a risk reward 1:5, offsetting the losses.

To increase the odds of being right, we need two ingredients:

• Good enough timing that tells us we are not too early nor too late for the party

• Long enough time before options expire to give a chance for the thesis to play out.

Those rules seem contradictory at first glance, but they support each other. If I fail to pick a good timing, I am still in the game by selecting an option with a long life span. Treat those rules as circuit breakers. If I am wrong about the time, the first breaker trips. However, the second (long-duration option) is intact until expiration.

This is my approach to playing commodities. It is the result of many trial-and-error repetitions. In other words, I had to figure out what did not work for me. Then, it was easier to pick from the few remaining options. More philosophically,  I learned who I am once I unlearned who I am not. First weed, then seed.

That being said, LEAPS combined with ETCs is not a universal approach that fits all. Such strategies do not exist. Consider today’s article as an idea generator, nothing more.

PS: Options are the most comprehensive tools to manage risk. As such, they are complex and require deep understanding. Even simple strategies such as LEAPS have many pitfalls. Before using options, ask yourself why you pick derivatives over equity. If the answer is to make more money, please stick to equity.

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Everything described in this report has been created for educational purposes only. It does not constitute advice, recommendation, or counsel for investing in securities.

The opinions expressed in such publications are those of the author and are subject to change without notice. You are advised to do your own research and discuss your investments with financial advisers to understand whether any investment suits your needs and goals.