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How Far Down Can the Miners Go?

The precipitous drop in Allied's share price included a exceedingly large volume spike. During a typical trading week for Allied, less than 5 million shares traded hands. Last week, more than 14 million shares traded, what one may cautiously consider a possible capitulation by the weak hands. If so, why did the selling continue through Monday, with another 4.8% drop?

It doesn't appear short-sellers are ramping up on shares, which I may even consider slightly bullish at this point (they have to cover at some point). Short interest data is always outdated; however, the data suggests the trend is lower, and short-sellers are covering.

If true, it's hard to picture a much more bullish indication other than seeing the actual price moving higher. Short-sellers are the smart money, and when they see the exit ramp, you should pay attention. Newmont and Goldcorp's short interest has fallen also, however, from a relative point of view, Allied's short interest is falling fastest and most clearly.

I believe the shorts buying back borrowed shares are illuminating the tunnel to profits. If they want to buy shares, maybe it's time to look for opportunity. One way to gain exposure while lowering your risks is through options.

Instead of buying the shares for about $12 a share, selling put options will allow you to capture some of the elevated fear premium currently priced into Allied. One idea is to sell the May $12.50 strike put for $1.40 or more. Your total risk is reduced from $11.85 a share, down to $11.40.

If Allied's shares move higher to above the strike price, the entire option premium is collected and gained. If the shares move lower and are put to you, the cost basis is $11.40, and they can either be liquidated or call options can be sold against them, further lowering your cost basis.

If the shares bottom, but stay in a narrow range, you still profit. This is one of my favorite reasons for writing options. You don't need the price to move in your direction. As long as the price doesn't continue to go against you, you profit. If the price does move in your favor by only 6% by the time the contracts expire, your profit is more than 12%.

Disclosure: The author holds no positions in stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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