Snap Up Steel as It Catches Up to Autos

by Tyler Craig | January 15, 2013 6:15 am

One industry that has been leading the charge higher in recent days has been automobiles. The Dow Jones US Automobiles Index has surged more than 21% in the past month alone. Amid this sea of optimism, both Ford (NYSE:F[1]) and General Motors (NYSE:GM[2]) have risen to new 52-week highs on heavy trading volume.

Of course, with some auto stocks having already rallied 20%-plus since mid-December, many traders might think they’ve missed the boat. I don’t doubt there will be more upside — particularly if the broader bull market in stocks continues — but it’s certainly easy to agree autos look a bit extended here. Fortunately, a few sympathy plays might provide better risk-reward opportunities.

The fate of steel stocks has been strongly intertwined with the auto industry. When you think about it it, such a strong correlation shouldn’t be all that surprising — after all, steel is one of the biggest inputs to vehicle production.

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As shown in the accompanying chart, the Market Vectors Steel Index Fund (NYSE:SLX[3]) has moved in lockstep with the US Automobiles Index. The correlation study included at the bottom of the chart shows both indices currently boast a positive correlation of 0.78.

Perhaps the most notable development of late is the magnitude of the rise in autos vs. steel stocks. Though SLX has participated in the bullish run these past few months, it has lagged the Automobile Index by a fair amount. Traders who believe SLX is due to catch up to the autos’ performance might consider some bullish plays in the steel space.

Unfortunately, while SLX is a great proxy for the broader steel industry, it’s far from the best trading vehicle — particularly for options traders. Though options are listed on SLX, they are very inactive and possess wide bid/ask spreads. Instead, I’d suggest looking to individual steel companies.

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Of the bunch, Nucor (NYSE:NUE[4]) is one of the better-looking steel stocks right now. It’s in the midst of a strong uptrend and is a stone’s throw away from breaking out to new multiyear highs over resistance at $46.

Traders looking for a sustained breakout in NUE could buy the April 45-47 bull call spread. To initiate the position, buy the Apr 45 call while selling the Apr 47 call for 95 cents or better. The max risk is limited to the initial 95 cents paid and will be incurred if NUE sits below $45 at April expiration. The max reward is limited to $1.05 and will be captured if NUE rises above $47 by expiration.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

  1. F:
  2. GM:
  3. SLX:
  4. NUE:

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