Options Corner: Why Trump's Policy Backflip Gifts A Discount For Southern Copper

At this point, the so-called TACO trade has become a well-worn meme. A pejorative that stands for "Trump Always Chickens Out," it describes the tendency of President Donald Trump to first issue a stern warning, then later walk back his own threats. This time around, Southern Copper Corp SCCO has felt the immediate impact of the policy whiplash. Still, despite the political drama, SCCO stock could make for an intriguing idea for contrarians.

Initially, the Trump administration's policies were supportive of rising share prices in domestic copper-focused enterprises. Early last month, the White House announced a surprise 50% import tariff on the key industrial metal — a dramatic boost from the 25% tariff announced previously. The shot fired across the bow sent demand surging for U.S. copper, which created an unusual arbitrage, with domestic prices reaching an over 25% premium relative to global prices.

However, earlier this week, the Trump administration issued another surprise: refined copper will be excluded from the sweeping 50% import tariff. Naturally, the move abruptly ended the months-long rally mostly sparked by trade restriction anxieties. In turn, Panmure Liberum analyst Tom Price bluntly assessed the matter. "Markets are now busily repricing refined copper much lower after Trump's epic backflip on his own import tariff policy," the expert remarked.

While this dynamic doesn't look good for SCCO stock — which is down about 7% over the trailing five sessions and down more than 10% in the trailing month — it could open a discount in an otherwise fundamentally sensible trade. The harsh reality is that the expanding and modernizing global economy requires more copper, not less.

For example, a study earlier this year from the Society of Economic Geologists (SEG) warned that copper prices would need to more than double to effectively support the global energy transition. Further, with accelerating investments in artificial intelligence, data centers will inevitably expand. Such initiatives require copper — among other elements — which should bolster overall demand.

Identifying A Possible Asymmetric Edge In SCCO Stock

While the narrative for Southern Copper is awfully enticing given the global demand backdrop, it doesn't provide specific guidance for how the market will respond. Unfortunately, investors collectively may have their own rationale, which may be different from your expectations — no matter how well-reasoned they may be. To truly decipher market sentiment, one must consider objective truths.

It's here that analysts commonly turn to financial metrics such as earnings or share prices. But the main challenge with these metrics is that they are continuous scalar signals. Even more problematic from an analytical standpoint, they are unbounded, meaning that they could theoretically rise indefinitely. By logical deduction, this means there is no way to objectively determine what a "good price" is or what defines "bad earnings."

Just about the only first-order principle we can rely on is that, at the end of the day, the market is either a net buyer or a net seller. In other words, we can't say objectively what "fast" means. But we can determine whether an object is in motion (kinesis) or not (stasis). And critically, both can't be right at the same time.

Looking back at the past 10 weeks, we can see that the market voted to be a net buyer of SCCO stock four times and a net seller six times. Despite the balance of distributive sessions outweighing accumulative, the security still managed to rise. For brevity, we can label this sequence as "4-6-U."

At first glance, it may seem incredibly strange to compress the price magnitude of SCCO stock into a simple binary code. But what we have accomplished is to create a falsifiable behavioral state. We can then look back at not only the frequencies of this state but also how the market responded to it. In addition, we can create a decision-tree logic by conducting this exercise across rolling 10-week intervals (going back to January 2019):

From the table above, we can see that the likelihood of a long position in SCCO stock rising on any given week is 52.77%, a modest upward bias. This is essentially our null hypothesis, the assumption of no mispricing. In contrast, our alternative hypothesis is that there is a probabilistic mispricing, in that the chance of upside due to the flashing of the 4-6-U sequence is 63.64%.

Think of this approach as counting cards in blackjack. At certain points, the deck will favor the bettor and at other points, the dealer. Since you're the bettor, it behooves you to act when conditions favor you and sit out when they don't. This is the crux of applied game theory.

Assuming the positive pathway, the median expected return is 1.46%. Assuming a closing price of $91.50, SCCO stock could get close to the $93 level relatively quickly.

An Intriguing Proposition

With Southern Copper scheduled to release its earnings report on Aug. 12, the most aggressive speculators may consider the 97.50/100.00 bull call spread expiring Aug. 15. This transaction involves buying the $97.50 call and simultaneously selling the $100 call, for a net debit paid of $95. Should SCCO stock rise through the short strike price ($100) at expiration, the maximum profit is $155, a 163% payout.

However, the above transaction requires a positive response to the earnings report, which is simply difficult to predict. A more palatable idea may be the 92.50/97.50 bull spread expiring Sep. 19. This trade gives more time to expiration at a lower strike price and thus a higher chance of profitability. The drawback, though, is that the net debit required is $225, with a max payout of 122%.

Finally, one point to consider is the small sample size of the 4-6-U sequence. Because of this fact, the p-value of the sequence is 0.3363, which means that there's a 33.63% chance that its implications can materialize randomly as opposed to intentionally. Admittedly, this isn't the greatest metric so caution is warranted. On the other hand, the relatively high payout helps offset some of the statistical ambiguity.

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