Shares of auto companies surged in Monday’s trading session in response to news that vehicle sales were on the rise in China. According to the China Association of Automobile Manufacturers, auto sales increased 19.5% in January versus a year ago. The rally in automakers like Ford (NYSE:F) and General Motors (NYSE:GM) helped drive the Dow Jones US Automobile Index higher by 1.91%.
Auto stocks enjoy membership in a sector that has scored the best performance since the infamous stock market bottom in March 2009. The sector, of course, is consumer discretionary, which is up more than 230% over the past four years, as shown in the accompanying chart. Sometimes referred to as cyclicals, this sector consists of economically sensitive companies that sour during recessions, but soar when the economy finally rebounds.
Click to Enlarge The rapid rise in the Automobile Index — up 47% since August 2012 — shows the market is continuing to price in improved economic conditions for automakers. Although car stocks kicked off the new year with a mild downturn, the correction terminated at the 38.2% retracement level of the August-January upswing. Proponents of Fibonacci retracement levels contend that pullbacks amid an uptrend often rebound at the 38.2% zone as buyers step up to accumulate shares on the cheap. That certainly proved to be the case this go-around.
Alongside the rebound, shares of Ford have turned higher, resuming their multimonth uptrend. With Monday’s 2.77% rally, Ford also broke back above its 50-day moving average and looks as if it might revisit its early 2013 highs at $14.30.
The implied volatility for options on Ford currently sits at a multiyear low, which means the cost for options is quite cheap. Traders looking for a more aggressive play could buy the June 13 calls for 80 cents or better. The risk is limited to the initial 80 cents, and the reward is unlimited.
Those looking for a more conservative approach could enter a call spread by buying the June 13 call and selling the June 14 call for a net debit of 45 cents. The max risk is limited to the initial 45 cents, which is almost half the risk of just purchasing the June 13 call. The max reward is limited to the distance between strikes minus the net debit, or 55 cents. Although the profit potential is limited, it’s still more than a 100% return on investment if Ford can rise above $14 by June expiration.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.