Scalp a 67% Potential Payout in First Majestic Silver (AG) Call Spreads

Previously taking a backseat to gold’s blistering run, the silver market has been hogging the spotlight recently. Earlier this year, the white metal was trading hands around the low-$20 range. At the moment, it’s just under $34 and threatening to swing higher. That’s excellent news for mining specialist First Majestic Silver (AG), which gained almost 21% in the trailing five sessions.

To say that AG stock is on a positive streak would be an understatement. On Thursday, First Majestic stood among the companies listed in Barchart’s Hot Prospects screener. Billed as one of the trading resource’s favorite screeners to find high-performing securities, all entities on this list must have a “Buy” Trend Seeker rating. In addition, the equity unit must wield a set of strong technical signals.

Presently, AG stock ranks as an 88% Buy, with the broader trend suggesting a solidification of its short-term (positive) outlook. Fundamentally, that makes sense. Investors are bidding up precious metals ahead of a contentious presidential election. Fears of the dollar weakening have also led to interest in alternative investments, which include silver and even cryptocurrencies.

However, it’s also fair to point out that not everything about AG stock is appealing. In particular, share dilution risks represent a significant concern. So, the longer-term narrative may encounter some headwinds. But if we’re only interested in a quick scalp, First Majestic could be quite intriguing.

A Bull Call Spread in AG Stock Warrants a Closer Look

While AG stock may be one of the leading candidateg in the Hot Prospects screener, there’s always a risk that robust enthusiasm can yield less-than-anticipated growth. It’s not that the barbells have been dropped, per say. Rather, the reps are becoming much more labored.

In such a situation — especially when targeting a short time period — a bull call spread could be an ideal weapon. A debit-based options play, the bull call spread is similar to buying a straight call option with one notable difference: you’re also selling a call at a higher strike price.

Why bother selling a call? For one thing, the credit received from underwriting the option will reduce the debit paid for the purchased derivative. That makes the call spread cheaper than buying just the call option associated with the first (i.e. long) leg of the trade. Second and just as importantly, the credit received lowers the profitability threshold of the wager.

Of course, bull call spreads are not without their drawbacks. Mainly, the spread limits downside risk but it also caps the total return. Still, even here, context is important. Yes, if a security shoots higher, a straight call would have been the superior option. But if you’re dealing with a short time horizon, a lower threshold to profitability could be far more valuable.

Let’s suppose that we want to speculate on the options chain expiring next Friday (Nov. 1). With AG stock closing at $7.82, targeting the $8 call option might seem attractive. However, the ask on this derivative landed at 22 cents. That means AG would need to hit $8.22 (up 5.12%) just to break even on the call.

Instead, you might consider the 7.50C(all) / 8.00C spread. The 19-cent bid on the second (short) leg partially offsets the 49-cent ask of the long leg. This transaction reduces the net debit paid to 30 cents while lowering the breakeven threshold to $7.80. Even better, AG stock only needs to hit $8 (up 2.3%) for investors to earn the maximum payout of 20 cents.

Putting 30 cents at risk to see a potential return of 20 cents gives us a payout of 66.67%. That’s not bad if you’re anticipating a quick pop in the silver miner.

Leverage Works Both Ways

Let’s imagine that AG stock gained the 2.3% necessary for the security to hit $8. If you had bought $300 worth of First Majestic shares, you would have a profit of $6.90. On the other hand, that same $300 in the aforementioned bull call spread would net you $200 in profit. That’s the power of leverage.

However, leverage also works the other way ‘round. If AG stock dropped 2.3%, those who invested the $300 into the actual security would lose $6.90. However, the folks who bought the call spread would lose $160. With options, you want to have a higher-than-average level of confidence.

Nevertheless, if you want blistering returns in the shortest amount of time, multi-leg options trades like the bull call spread may be your best bet. By playing around with various iterations, you can potentially find a transaction with a reasonable likelihood of success.

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On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.