Trade of the Day: U.S. Steel (X)

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The market ended mixed to start last week, as the Dow’s Monday winning streak ended at three with the slight pullback. Biotech stocks were weak after Wall Street said the sector was “overvalued,” and transport stocks pulled back as well, which was a warning that trouble could lie ahead.

Tuesday’s action provided clues that the bears were serious, as the S&P 500 Volatility Index (VIX) closed above 13.50. I warned that 15 could come into play quickly, and Wednesday’s weakness came right on cue, with the VIX closing above this level. The bears got a 2% win and pushed the bottom uptrend lines as Wall Street ran for the exits.

There were bullish signs that showed some pressure might be relieved on Friday’s rebound, and near-term support held. But there is one particular stock that I’m recommending for a bearish trade: United States Steel Corporation (X). Shares did make a strong move above their 50-day moving average in mid-March — but this level held briefly in February for a few days before a backtest to $22. Otherwise, the 50-day moving average hasn’t held since October of 2014.

There is risk to $26, but I wanted to get into X put options, as I expect shares to trade to $22–$20 on a drop below $24. Thursday’s low reached $24.04.

There is risk to the trade, as the company asked Congress yesterday to approve trade laws that will help the industry. Steel prices and demand have suffered as a result of the U.S. market being flooded with low-cost imported foreign steel. U.S. Steel has been idling plants due to the softness, and workers have been laid-off. This is not just a problem with U.S. Steel, as the dominoes have tumbled at other steel manufacturers.

The other risk to the trade is that U.S. Steel is often subject to takeover chatter. But, with X’s current market cap of $3.6 billion, I doubt another company will come in at these levels to form a major conglomerate. In my opinion, if shares of U.S. Steel stumbled into the teens, maybe the water-cooler talk would become more serious.

Earnings are estimated to be released in early May, but analysts have been dead wrong on their coverage of the stock. There is no homework being done on Wall Street, as the company has beat estimates the past four quarters by a wide margin. Earnings have come in above expectations by $0.95, $0.99, $0.46 and $0.03, respectively.

The suit-and-ties have the company earning $0.32 a share for the current quarter on revenues of $3.54 billion. My guess is that the company will fall short on revenue estimates, but earnings are a mystery.

The company could issue a pre-earnings announcement if they are going to come up short on these numbers…and they should, given the current chaos in the industry. The perfect time to sweep the news under the rug would be after next Thursday’s close, with Wall Street on vacation for Good Friday. Of course, with the cuts and trimming of the fat, earnings could top “expectations” once again — but, given X’s deteriorating fundamentals and nasty chart outlook, the best trade here is still a bearish one.

Buy to open the X May 21 puts (X150515P00021000) at current levels, around $0.60. These are the regular monthly options that expire on May 15. I used the May options to give the trade nearly two months to play out. While there could be short-term volatility, the longer-term chart is showing me that shares could test the mid-teens this year.

Resistance for U.S. Steel is at $25–$26. A close above $27 and the 100-day moving average would be bullish. Support is at $24, followed by $23.50 and the 50-day moving average. I’m looking for a test to $20 by mid-May.

If a move to $20 comes by mid-May, these options would be valued at $1.00. Or, if shares are at $19.50, technically, by May 15, these options will be worth at least $1.50, which would represent more than double current levels. But my specific exit target is $1.20.

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