Thursday, February 3, 2011

Molycorp - Anatomy of a Successful Trade

In many ways trading is like golf. In both cases you are competing against others, but you're also constantly battling yourself to do the right things, stick to your game plan, etc. And while in golf you are always trying to hit that perfect shot, in trading you are always trying to make that perfect trade. And every now and again, if you stick to your strategy, you succeed. Molycorp (MCP) was one of those "perfect trades" for me this past week.

I'm not saying this would be everyone's perfect trade. Everyone has different trading strategies, and different objectives. But for me, the outcome was what I envision and hope for on almost every trade I put on.

And I'm not writing this to brag (I've had many horrible trades as well, and will highlight some of them at a future date). I am writing it to so that it will be a constant reminder to myself as to what a good trade looks like, and at the same time hopefully it will help other traders searching for their own "perfect trades".


Like many traders, I had been watching MCP off and on since it IPO'd back in the summer for around 13 bucks. Over a span of 5 months it rose nearly 400% hitting a high of 62.78 on Jan 4. Once it started to come off its highs, I began to look at the charts to figure out what level might provide a good risk/reward to get long.

Traders had been steadily selling the stock since the beginning of the year, and with the insider lock-up period ending on Jan 25 traders were starting to short the company aggressively on anticipation of a glut of shares being dumped on the market. I figured the 50 day moving average would be a natural level to attempt a long, but due to the lock-up period ending I decided I was going to wait until after Jan 25 to see how the stock reacted.

Then on Jan 24, with the stock down once again, the stock was halted and the company announced the following:
  • A doubling of their planned production
  • A $172.5 million convertible preferred stock offering
  • A secondary offering of common stock for up to $500 million
Now as it turns out, the company had already hinted back on Jan 4 that they would consider doubling their production. So for those closely following this company this shouldn't have come as a huge surprise, but it did appear to be a surprise to many and was clearly a positive development. The $172.5 million convertible preferred stock offering would be used to help finance this expansion.

What caught my eye was that the $500 million common stock offering would be used to help facilitate the liquidity objectives of a number of early shareholders, led by Resource Capital Funds. This told me that the number of shares that could hit the market on Jan 25 would not be nearly as large as the market was fearing. And not only was the market concerned about this expected supply of shares, it had aggressively shorted the stock in anticipation of it.

This was a no-brainer...
  • The stock was oversold
  • The company had just announced a doubling of their planned production
  • There was no longer a glut of shares to suddenly hit the market on Jan 25, and
  • The stock was heavily shorted.
Unfortunately by the time I digested the news the share price had already touched the 50 day moving average @ 40.46, trading as low as 40.25, and then almost immediately jumped about 10% to 44.50.

By the time I got long I was lifting 44.89's. Let me tell you, lifting an offer 10% higher than where it was just minutes earlier is not an easy trade. But given the facts listed above I knew I had to be long. And having both the fundamentals and technicals in agreement gave me the confidence I needed to pull the trigger. It also gave me the confidence to trade around the position.

I set my stop under 43.50, figuring if it traded back down then I mis-read the situation. My technical target was 50+. Specifically I was looking at 51.50, as it represented the 50% retracement from the Jan 4 high to the 40.25 low on Jan 24. That represented a risk to reward ratio of almost 7:1. And I figured my upside target could be reached within about 2 weeks. Those types of opportunities don't come along every day.

For those that are interested, here are the exact trades I made between Jan 24 and Feb 2 when I closed out my position:
  • Jan 24 - Bought 1,000 shares @ 44.89
  • Jan 24 - Sold 300 shares @ 46.71
  • Jan 25 - Sold 400 Feb55 Calls @ 1.55 (great way to extract extra cash with implied vol spiking)
  • Jan 26 - Bought back 400 Feb55 Calls @ 0.55
  • Jan 26 - Bought back 300 shares @ 45.11
  • Jan 27 - Sold 400 shares @ 47.155
  • Jan 28 - Bought back 200 shares @ 45.56
  • Jan 31 - Sold 400 shares @ 46.43
  • Feb 2  - Bought 200 shares @ 49.80
  • Feb 2  - Sold 300 shares @ 50.22
  • Feb 2  - Sold 300 shares @ 51.47
Net Profit = $4,862

Of course, the stock continued to climb this afternoon and closed the day @ 53.25, so one could argue that I left some money on the table. I'm ok with that. I had a strategy when I entered the trade and I followed it. I will not have any regrets if it trades to $80 by the end of the week.

Good luck and good trading.

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