Brazilian iron ore and coal mining specialist Vale SA (ADR) (NYSE:VALE) enjoyed a banner year in 2016. VALE stock rocketed more than 160% last year, with serious gains taking place in the wake of the U.S. November elections.
Alongside President Trump’s calls for increased infrastructure spending, demand rose sharply in China due to an accommodative monetary policy. But the situation is about to sour, providing an opportunity for VALE options traders.
While he campaigned on more than $1 trillion in infrastructure spending, Trump has actually shown very little progress on this front. With the administration mired in scandal after scandal and Congress focusing heavily on health care reform, infrastructure has taken a back seat.
As for China, leadership in Beijing is signaling that credit expansion is getting a little out of hand — meaning a cooling period is in order. As such, steel stockpiles are growing in China, with iron ore held at Chinese ports rising to 130 million tons.
Both developments have already had a chilling effect on VALE stock. The shares are already down more than 15% since their February peak, and losses could get worse from here, barring any major policy move from Washington. Currently, VALE is consolidating into round-number support near $10, but a breach of this support could send the shares sharply lower as a result.
On the sentiment front, VALE is quite vulnerable. Thomson/First Call reports that only nine of the 24 analysts following the shares rate them a “buy” or better. These tentative nine are likely banking on increased infrastructure spending from the Trump administration to help drive iron and steel prices. Continued delays on this front could prompt a reversal from these bullish holdout.
What’s more, VALE stock is trading right at its 12-month consensus price target of $10.18, hinting that valuation could also be a concern within the brokerage community.
Click to Enlarge As for VALE options traders, the April put/call open interest ratio has risen in recent weeks to arrive at a somewhat bearish reading of 1.12.
Puts are clearly being added at a faster rate than calls among short-term traders, indicating expectations for continued short-term losses as global demand for steel and iron ore sorts itself out.
Overall, April implieds are pricing in a potential move of about 11.7% for VALE stock ahead of next month’s expiration. This places the upper bound at $11.17, while the lower bound rests at $8.83.
With serious geopolitical risks to Vale’s bottom line, a breach of support near $10 could see VALE stock’s decline exceed even options traders’ expectations.
2 Trades for VALE Stock
Bear Put Spread: With plenty of downside risk for VALE stock, traders looking for a bearish play might want to consider an April $9/$10 bear put spread. At last check, this spread was offered at 8 cents, or $8 per pair of contracts. Breakeven lies at $9.92, while a maximum profit of 92 cents, or $92 per pair of contracts, is possible if VALE stock closes at or below $9 when April options expire.
Call Sell: Another way for VALE traders to profit from this development is to sell out-of-the-money calls — especially if you own VALE stock. Traders taking a more neutral-to-bearish stance might consider selling the April $12 call. If you already own VALE stock, this call sell allows you to offset some of your portfolio losses in the event of continued stagnation, but also allows you exposure to any upside up until the stock trades at or above $12.
At last check, this option was bid at 18 cents, or $18 per contract. A sold call allows you keep the premium as long as VALE stock closes below $12 at expiration.
On the downside, if VALE rallies above $12 prior to expiration, you could be forced to provide 100 shares at current market value for each call sold, which could be quite costly if you do not have enough stock on hand to cover the call.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.
