Trade Update – Catching a falling knife in NEM – take the loss

by Enis May 17, 2012 9:43 am • Commentary

Trade Update May 17th, 2012 at 10:00 AM:

This trade did not go as planned, and when a trade does not go as planned, you take your loss and move on.  I thought the gold miners were technically set up for an oversold bounce, with NEM in particular looking ripe for a move above 47, but the gold miners have continued to be one of the worst performing sectors as the market has sold off.

Fortunately, NEM has outperformed the broader group, and is now sitting above the 44 strike, so we won’t have to take a max loss on this trade, but I’m going to use today’s strength in the precious metals to take this trade off for a loss.  I originally collected $1.35 for selling the May 47 / 44 put spread.  Today I am buying this put spread back for $2.35, for a $1.00 loss.  I debated rolling this trade to June, but in my experience, I’m better off just taking my loss and moving on to other opportunities rather than trying to salvage a losing trade.

Original Post May 7th, 2012:

One sector that has been a complete dog this year is the gold miners.  GDX is down more than 15% year-to-date, selling off almost in a straight line in March and April, after rallying with the market at the start of the year.

Incredible chart of the Gold Miners vs. SPX YTD:

While you might just attribute it to gold and silver moving lower, both precious metals are still positive on the year.  Moreover, as humblestudentofthemarkets pointed out this morning, bullish sentiment in the sector is around multiyear lows on some metrics.

The name that stands out to me is NEM, cheap on valuation (10 P/E), a now 3% dividend yield after the selloff this year, and a decent earnings report 2 weeks ago.

Finally, the technicals look close to signaling a turn, as volume has dwindled on each subsequent move lower, and the RSI is making higher lows, indicating reduced momentum in the selloff:

While I normally prefer to buy strength and sell weakness, the bounce play on NEM has a number of macro and technical factors going for it, so here’s the trade:

TRADE: NEM ($45.90) Sell the May 47 / 44 Put Spread for 1.35

-Sell 1 May 47 Put for 1.70

-Buy 1 May 44 Put at 0.35

Break-even on May Expiration:

-Profits between 45.65 and 47, make up to 1.35, max gain 46 or higher of 1.35

-Losses of up to 1.65 between 44 and 45.65, and max loss of 1.65 below 44

The trade does not look like great risk / reward at first glance, but it’s a good way to try to catch a falling knife and define my risk, with my thought that the probability of a bounce in NEM over the next week is greater than the odds I get based on the setup.  I have more confidence in the stock bottoming out than in a significant rally, hence selling a put spread as opposed to taking a shot by buying a call spread here.