by Tyler Craig | October 12, 2012 6:30 am
The majority of the time the three major indices — the Dow Jones, S&P 500 and Nasdaq — paint an identical picture, making the analysis of all three a bit of a redundant exercise. If after reviewing the chart of the S&P 500 Index one concludes the market is bullish, it’s a good bet the same conclusion would have been drawn from reviewing the chart of the other two.
And yet, sometimes, one index begins to move to the beat of a different drum, causing a divergence to form.
We’ve seen just such a discrepancy arise in recent weeks as the tech-heavy Nasdaq has followed a decisively more bearish path by breaking its 50-day moving average and key support levels. If the Nasdaq is any indication, it appears a correction is upon us.
Market corrections come in all shapes and sizes. Some are comprehensive in nature, seeping into every sector and industry group. Like an octopus, they wrap their innumerable tentacles around all securities tied to the risk-on trade before taking a plunge into the deep. Other corrections turn out to be short-lived incidents isolated to a few vulnerable sectors only.
It appears the current market correction is one of the latter variety. Rather than seeing money flee the stock market en masse, we’ve witnessed rotation of a sort where technology stocks have been jettisoned in exchange for financials and basic material stocks.
Click to Enlarge Take a look at the accompanying chart, which displays the past week’s relative performance of a trio of basic material-related ETFs — SPDR S&P Metals and Mining (NYSE:XME), Market Vectors Steel (NYSE:SLX), and Market Vectors Coal (NYSE:KOL) — along with the Select Sector Financials SPDR (NYSE:XLF) and Select Sector Technology SPDR (NYSE:XLK). The weakness in technology has been matched by impressive strength in the other areas.
While traders might be able to cobble together a number of trade ideas from this recent rotation, let’s focus on the steel space.
Unfortunately, the Market Vectors Steel ETF is plagued by low volume and options that lack adequate liquidity. As such, any plays in this sector will need to use individual steel stocks.
Click to Enlarge United States Steel (NYSE:X) is one such candidate that has stabilized in recent months, forming a symmetrical triangle pattern. We’ve also seen a few higher-volume up-days, indicating potential institutional accumulation.
Traders willing to bet steel stocks continue to benefit from sector rotation might consider selling the Nov 20 put option on X for 85 cents or better. Provided X remains above $20 by November expiration, the put option should expire worthless, allowing traders to pocket the entire 85 cents received at trade entry.
To minimize risk, consider buying back the short put if X falls beneath support at $18. U.S. Steel does have an earnings announcement coming up on Oct. 30, so traders unwilling to roll the dice going into the event might consider closing the trade beforehand.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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