Fundamentally, gold specialist Newmont Mining ($NEM) offers investors a compelling vehicle to potentially generate positive returns. With the underlying yellow metal continuing to break price records, jumping onboard the precious metal sector seems incredibly logical. Newmont is the world’s leading gold company, making NEM stock powerfully relevant.
In all fairness, the commodities sector can be volatile at times. For example, on Friday, September 27, NEM stock closed down almost 3%, and lower for the week despite continued strength in the price of gold. Since the start of the year, Newmont has delivered stock price upside of more than 30%.
Outside factors, particularly the Federal Reserve’s dovish monetary policy, provide continuing support for the precious metals space. Metals don’t themselves offer any distribution yield, therefore their relative appeal tends to improve when interest rates decline. Outside of a significant catalyst to arrest the upward trend of gold, I believe Newmont’s valuation should continue rising. Therefore, I am bullish on NEM stock. However, I’d like to present a method for picking up some income using a multi-leg options strategy.
Feeling Out the Market Before Diving into NEM Stock
An investor could simply choose to buy NEM stock in the open market. This is a debit strategy: an investor pays the current ticker ask price to acquire shares. Basically, the investor would commit themselves to a cash outlay, and hope that the stock rises in value to generate a profit.
With options pricing, there are inefficiencies on observable data and quantifiable metrics. One common metric is implied volatility (IV), which is derived from market sentiment and expectations of future price movements, and historical volatility (HV), which is based on actual past security price fluctuation.
It’s possible to write entire volumes of literature on the subject of volatility measures alone. However, for our purposes, when IV is elevated relative to HV, it implies that options are priced higher than normal. In this case, it may be attractive for investors to consider selling (writing) options — a credit-based strategy — rather than buying them (debit based).
Applying the Appropriate Strategy for Newmont Mining
The current average IV for NEM stock options stands at 34.66%, whereas the HV sits at 25.40%. Further, the IV percentile — or the relative level of IV compared to prior periods — has generally been rising since September 18. This framework suggests that NEM options are priced higher than what is normal for the Colorado-based gold miner. Therefore, a credit-based strategy called a bull put spread may be appropriate.
As stated earlier, I’m bullish on NEM stock, mainly because of the ongoing rise in gold prices and the Fed’s likely support of dovish policies. Unless something radically changes, I have high confidence in the near term that NEM will continue marching higher. At the same time, I want to be smart about the potential opportunity.
As noted, IV is running hotter than HV for Newmont stock right now. It may be more prudent, and less speculative, to wager that NEM stock will not decline, as opposed to betting that it will rise further. In my view, it’s more appealing to underwrite the risk that NEM will not fall rather than speculating that it will move higher.
Trading the Bull Put Spread Strategy
Specifically, the bull put spread involves two legs of a same-expiration options chain. On the first leg, we sell a put and thus generate a credit from it. Simultaneously, on the second leg, we buy a put at a lower strike to cap the risk of assignment (should the trade go against us). We pay a premium for this second leg. What we are left with is the net credit/income or net premium received.
One idea to consider, for the options chain expiring Oct. 11, is to sell the $54 put at a bid of $1.00. Simultaneously, we buy the $51 put at an ask of 23 cents. The net income received for this setup would be $0.77/share, or $77 per contract. This is also our maximum reward. On the flip side, the max loss comes out to $2.23/share. Break-even comes in at a share price of $53.23.
So long as NEM stock doesn’t fall below break-even, we should be profitable. Also, if shares manage to be at or above $54 at expiration, we will end up profiting by the full premium of $77 per contract. That seems a very reasonable target considering that NEM closed at $54.14 on Tuesday October 1.
Why Bother with the Bull Put?
If we are so bullish about NEM stock, why not just sell the $54 put outright and not deal with capping our potential reward? Simply stated, no one knows what’s going to happen in the future. Therefore, it’s prudent to consider risk-managed trades such as bull put spreads (which fall under the category of vertical options spreads).
Most importantly, selling options — whether they be calls or puts — outright is incredibly dangerous if they’re uncovered with shares (in the case of calls) or with cash (in the case of puts). That’s because as underwriters of risk, if the trade goes against us, we must cough up our end of the options contract upon assignment (exercise).
However, underwriting can be a compelling mechanism to generate income through premium harvesting in certain market cycles. Plenty of retail investors don’t invest in leaning about these opportunities. Even fewer investors know that you can underwrite risk while also providing yourself with downside insurance. That’s the beauty of the bull put spread.
Wall Street’s Take on Newmont Mining
Ten analysts on Wall Street cover Newmont Mining stock on the NYSE. They offer NEM a consensus Moderate Buy rating based on six Buys, four Holds, and zero Sell ratings. The average NEM price target is $56.90, implying about 5% upside potential.
The Takeaway: There’s a Smart Way to be Bullish on NEM Stock
Thanks to rising gold prices and an accommodative Fed, the framework for precious metals miner Newmont Mining appears quite optimistic. Nevertheless, options pricing dynamics suggest that a credit-based approach is more favorable at this time. With a risk-managed bull put spread, investors can generate income off the thesis that NEM stock will not decline, rather than making a debit-based wager that the security will rise. In my view, this is one of the smartest ways to play Newmont at this juncture.
