Options Transactions Signaling Steel Resurgence
Joe Kunkle, Investment U Research Team
Late last year, steel stocks saw some of the sharpest sell-offs in the market.
The Steel Market Vectors Fund (NYSE: SLX) fell from $114 to $20, and most steel producing companies hit five-year lows.
The interesting thing is that we’re seeing signals in steel stocks that are strikingly similar to what we saw in coal stocks and the Market Vectors Coal (NYSE: KOL) in late April.
At that time, investors saw a 43% jump in about 10 days.
Just prior to that jump, coal stocks were seeing bullish positioning and large institutional traders buying far out-of-the-money call options. A handful of investors and traders profited handsomely.
If this pattern holds true, and steel stocks behave is a similar fashion, investors who jump back in could see sizeable returns. And there are a number of interesting ways to do it.
Ways to Play Steel Resurgence
From March lows to May highs, KOL rose 130% while SLX rose less than 100%. Based on the positions in out-of-the-money call options for steel players such as Arcelor Mittal (NYSE: MT) and United States Steel (NYSE: X) it appears that steel still has a lot of room to run much higher
For example, a trader bought 7,000 contracts of the July $33/$40 vertical call spread, a bullish position, paying $1.45 per spread. That’s a $10,150,000 bullish position in U.S. Steel.
In another trade someone bought 2,150 contracts of the September $32.50/$35 vertical call spread in Arcelor Mittal.
Both of these bullish call spreads are far out-of-the-money. A 33% move in U.S. Steel and a 20% move in Arcelor Mittal are required for these investors to reach maximum profit – a move above the high strike yields max profits.
Those are strong bets that steel’s on it’s way up.
One of the strongest leaders in this group, United States Steel was one of the earliest to raise new capital, and while its shares have stabilized over the past six months, its lack of movement suggests overlooked value – not just for US Steel, but for the sector.
SLX is looking promising for technical traders as well. At 41.00 it’s settling just below it 200 day moving average at $41.78. If you’re not familiar with technical indicators, if SLX breaks above $42.20 it sends a solid buy signal to buy either individual stocks or the SLX.
With a changing supply and demand picture, steel prices are stabilizing as massive production cuts are now being priced in. This will boost steel stocks for months to come. But it could be a while before we see substantial increases – and that’s why option traders are buying far out of the money calls for July and September.
However, their patience should pay off.
There are a number of ways to play this steel increase. On a valuation basis, Reliance Steel and U.S. Steel are the clear leaders in this space. But there are other strong contenders…
Rio Tinto ADR (NYSE: RTP), Reliance Steel & Aluminum (NYSE: RS), POSCO ADR (NYSE: PKX), and Nucor (NYSE: NUE) are the other top steel producers that are worth looking at.
But if you like being a bit more aggressive, speculative traders will find Russian steel producer Mechel OAO ADR (NYSE: MTL) a diamond in the rough with massive upside potential.
If you’re looking for yet another way to play the steel sector, consider takeover and merger activity. You can expect to see consolidation pick up once credit markets improve. And some of the most likely takeover targets look to be AK Steel Holding (NYSE: AKS), Steel Dynamics (Nasdaq: STLD), Commercial Metals (NYSE: CMC), and Gerdau SA (NYSE: GGB).
In short, the signals we’re seeing from options purchases in steel stocks are overwhelmingly bullish. If you’re not looking to mess with specific stocks you can always invest in the steel ETF. SLX. Either way should suit any investor at these price levels.
Good investing,
Joe Kunkle
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May 20th, 2009 at 5:19 pm
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