Indulge me for a moment, as I try to explain something I happened upon, and haven’t seen discussed elsewhere. In applying the deductions we’ve already covered - from identifying a potentially hot market, to finding a junior miner with good technical structure in low volatility, to scouting options contracts that offer incredible risk-reward on the trade - we might discover what I can only describe as a… mistake. You see, if you purchase an option, someone is selling it to you. Their hope is for that option to expire worthless, and they collect and keep the premium you paid. And because most options writers are professionals, they’re often right, somewhere on the order of 80% right. Which, if your math isn’t terrible, ought to make clear you’re playing a rigged game, with the edge in the other person’s favor.
But…
But that leaves 20-30% of trades that resolve in favor of us, the dumb money. And when they do, they generate open ended upside for us, and open ended risk for the options writer. And if purchased with Darvas level risk and precision, these winners can far outweigh the losers in terms of profit and loss.
But one must identify options with mispriced risk. You can see from the Greek’s above that options prices have a handful of variables which interact and impact one another. As such, they’re not absolute parameters, but are relative. And in low cost stocks oscillating in low volatility, these parameters don’t speak accurately to the real risk of impending volatility, which can be explosive. The Greeks change dramatically as both price and volatility of the stock increase.
I’ve been playing around with DNN (Denison Mines) options for the last year and a half. DNN is currently sitting just above $1 a share. You can, as of today, purchase call options with a strike price of $1.5 and 6-8 months of time to expiration for about $15 each. Since one options contract represents 100 shares, you’re essentially purchasing the upside on 6.5 times the number of shares you could get if you purchased the stock outright, with the fixed risk of $15.
These options prices aren’t going to last.
That alone isn’t enough of a reason to purchase, because, as we discussed, most options expire worthless, and the guy selling em to you may be a proper alchemist. But let’s say the price of uranium is on the move, and the price of DNN is coiling (both are true as of the end of May 2023).
Under similar circumstances over the last 15 years, the price of $DNN has jumped 300-400% in a matter of weeks to months. That’s the stock price, NOT THE OPTIONS VALUE! If the price were to double over the next few months, each contract would be .5 ($50) in the money - for a 3X profit. In the last two years, DNN has made that very move 3 times in the matter of weeks to a couple months, meaning it’s well within range for a reasonable move.
I’m expecting DNN to pass $10 over the course of the coming years, with several windows like this one, and several opportunities for entry. Implementing the trading strategy I dissect below, this is an example of a candidate for a 10-20X trade (our 2 out of 10 trade winners need to average about 7x returns).
To highlight just how awesome options with this risk profile are, to purchase a similar move on a $30 stock could cost 5-10 times that of a junior, with a lower probability of the stock moving to such a degree.
The sweet spot is inexpensive stocks during low vol windows at inflection points.
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