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Lithium Americas Covered Call Could Add Bounce To Share's Volatility

Published 2022-06-08, 10:03 a/m
  • Mining startup Lithium Americas shares are down over 14.5% in 2022
  • Benefits from Argentinian project likely in second half of this year
  • Long-term investors could consider buying the dip, especially if stock declines toward $24
  • For tools, data, and content to help you make better investing decisions, try InvestingPro+.
  • Vancouver headquartered, Lithium Americas (TSX:LAC) (NYSE:LAC) is a development stage resource company. The company has projects in Argentina and the U.S.

    Shareholders of Lithium Americas have seen the value of their investment increase by 54.3% over the past 12 months. However, LAC stock is down 14.7% so far in 2022. By comparison, the Solactive Global Lithium Index has lost roughly 10%.

    On the other hand, since the start of the year, shares of other lithium miners, namely Livent (NYSE:LTHM), Piedmont Lithium (NASDAQ:PLL) and Albemarle (NYSE:ALB), are up by 20.5%, 8.8%, and 8.6%, respectively.

    Lithium Americas Weekly Chart.

    Source: Investing.com

    On Nov. 30, shares in the natural resource giant went over $41 to hit a 52-week high. The stock’s 52-week range has been $12.56 - $41.56, while the market capitalization currently stands at $3.3 billion.

    Lithium Americas is a pre-revenue miner. Yet, LAC stock has seen a significant rally in late 2021 as investors bid up lithium assets, predicting booming demand for the metal used in batteries that power electric vehicles.

    However, Goldman Sachs has recently warned of a "sharp correction" in the price of lithium. The investment bank sees a decline of 10% during the second half of 2022. A further drop of 70% from current prices by 2023 could be in the cards.

    Meanwhile, Elon Musk, CEO of Tesla (NASDAQ:TSLA) lately suggested the car manufacturer may also venture out into lithium mining. As a result, many shareholders got spooked, and most lithium shares came under pressure in the past several weeks.

    Recent Metrics

    Lithium Americas released Q1 financials on May 5. The company is not currently producing lithium, hence the bottom line is still in the red.

    Quarterly net loss stood at $46.1 million, or a loss of 35 cents per share, compared with a net loss of $10 million, or 9 cents per share, in the same quarter a year earlier. Cash and equivalents ended the quarter at $492 million.

    While LAC’s project in Cauchari-Olaroz, Argentina, is expected to produce a total of 60,000 tonnes per annum (tpa) lithium carbonate, its project in Thacker Pass, Nevada, is targeting Phase 1 of 40,000 tpa and Phase 2 total capacity of 80,000 tpa lithium carbonate. On Apr. 14, management submitted a formal application to the U.S. Department of Energy for funding to be used at Thacker Pass through the Advanced Technology Vehicles Manufacturing Loan Program.

    Prior to the release of Q1 results, LAC stock was changing hands around $28. At the time of writing, it was at $25.10, down roughly 10%.

    What To Expect From Lithium Americas Stock

    Among nine analysts polled via Investing.com, LAC stock has an "outperform" rating.

    Consensus Estimates of Analysts Polled By Investing.com.

    Source: Investing.com

    However, according to a number of valuation models, like those that might consider P/E or P/B multiples or terminal values, the average fair value for Lithium Americas stock on InvestingPro stands at $18.34.

    Valuation Model By InvestingPro.

    Source: InvestingPro

    In other words, the fundamental valuation suggests shares could decline by around 27%.

    Our expectation is for Lithium Americas stock to trade in a wide range between $22 and $27 and build a base in the coming weeks. Afterwards, LAC shares could potentially start a new leg up.

    Adding LAC Stock To Portfolios

    Lithium Americas bulls who are not concerned about short-term volatility could consider investing now. Their target price would be $39, as per the target provided by analysts.

    Alternatively, investors who expect LAC stock to bounce back in the weeks ahead could consider setting up a covered call.

    Most option strategies are not suitable for all retail investors. Therefore, the following discussion on LAC stock is offered for educational purposes and not as an actual strategy to be followed by the average retail investor.

    Covered Call On LAC Stock

    Intraday Price At Time Of Writing: $25.10

    For every 100 shares held, the strategy requires the trader to sell one call option with an expiration date at some time in the future.

    A stock option contract on LAC (or any other stock) is the option to buy (or sell) 100 shares.

    Investors who believe there could be short-term profit-taking might use a slightly in-the-money (ITM) covered call. A call option is ITM if the market price (here, $25.10) is above the strike price ($22.50).

    So, the investor would buy (or already own) 100 shares of LAC stock at $25.10 and, at the same time, sell an LAC Aug. 19 $22.50-strike call option. This option is currently offered at a price (or premium) of $5.

    An option buyer would have to pay $5 X 100 (or $500) in premium to the option seller. This call option will stop trading on Friday, Aug 19.

    This premium amount belongs to the option writer (seller) no matter what happens in the future.

    The $22.50-strike offers more downside protection than an at-the-money (ATM) or out-of-the-money (OTM) call.

    Assuming a trader would now enter this covered call trade at $25.10, at expiration, the maximum return would be $240, i.e., ($500 - ($25.10 - $22.50) X 100), excluding trading commissions and costs.

    Break-Even Price

    At expiration, this trade would break even at an LAC stock price of $20.10, excluding trading commissions and costs.

    A way to think of this break-even price is to subtract the call option premium ($5) from the underlying LAC stock price when we initiated the covered call (i.e., $25.10).

    On Aug. 19, if LAC stock closes below $20.10, the trade would start losing money within this covered call setup. Therefore, by selling the covered call, the investor has some protection against a potential loss in the case of a decline in the underlying shares. In theory, a stock's price could drop to $0.

    What If LAC Stock Reaches A New All-Time High?

    As we have noted in earlier articles, such a covered call would limit the upside profit potential. The risk of not participating in LAC stock's potential appreciation fully would not appeal to everyone. However, within their risk/return profiles, others might find that acceptable in exchange for the premium received.

    For example, if LAC stock were to reach a new high for 2022 and close at $42 on Aug. 19, the trader's maximum return would still be $240. In such a case, the option would be deep ITM and would likely be exercised. There might also be brokerage fees if the stock is called away.

    As part of the exit strategy, the trader might also consider rolling this deep ITM call option. In that case, the trader would buy back the $22.50 call before expiry on Aug. 19.

    Depending on her/his views and objectives regarding the underlying LAC stock, the trader could consider initiating another covered call position. In other words, the trader could possibly roll out to a Aug. 19 expiry call with an appropriate strike.

    Bottom Line

    The exact market timing of when the decline in LAC shares could stop is difficult to determine, even for professional traders. But options strategies provide tools that might prepare for sideways moves or even drops in LAC price, especially if there is further volatility in the price of lithium.

    We regard covered call options as a potential way to earn additional income from your LAC stock portfolio. Such a strategy also helps lower portfolio volatility.


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