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Afraid to Chase? Try a Play in Steel

With the bull run morphing into a veritable stampede of vicious horns and hoofs, bears everywhere are cowering in their dens. Indeed, the ongoing bull market has left many a short-seller and top-picker maimed and mangled in its wake. Since the S&P 500 Index finally found its sea legs in late June following a wobbly response to Bernanke’s infamous taper remarks, it has risen almost 10%.

Many curious spectators wanting to finally jump into the fray face the difficult reality that many stocks have already ascended into the stratosphere. While chasing strength in a momentum-driven market can be rewarded from time to time, in the long run, buying stocks that are extremely extended from support zones is rarely a profitable venture.

Of course, not all segments of Wall Street have been full participants in the ongoing party. Some industries are just now starting to arrive at the bulls’ bash and therefore provide a potentially appealing alternative to the numerous high-flyers that have led the festivities thus far.

Most of these latecomers are tied to the commodity space, which has exhibited weak performance for many months. The strengthening U.S. dollar and relative weakness in emerging markets have undermined the commodity market’s attempt at returning to its former glory days — to say nothing of the fact that stocks are simply the best game in town right now.

The accompanying chart was included in one of John Murphy’s recent newsletters (subscription required) and clearly illustrates the impact that these two variables have had on commodities, as measured by the CRB Index:


Although the previously outlined evidence paints a rather poor picture for commodities, keep in mind that the markets are rotational in nature. As leading sectors encounter bouts of profit-taking, money often rotates into other areas which might become the new leaders for a spell. At some point, the beleaguered commodity sector will come back en vogue, you just need to wait for signs that bottoming fishes are starting to bite.

One of the more interesting charts in the sector is the Market Vectors Steel ETF (SLX). In mid-May, it staged a serious breakdown, breaching a key multiyear support level at $40. Unfortunately, the bears allowed a golden opportunity to slip from their fingertips. The breakdown became a fake-out, leading to a convincing 14% rebound over the past month.

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With SLX now back above its 50-day moving average and forming a nice high base pattern, the bulls have definitely established a foothold.

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Sadly, the liquidity of SLX options leaves much to be desired. Trading an individual steel stock like Nucor (NUE) might be the better route if you’re looking for option plays.

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Nucor looks poised to break above resistance, so consider selling a Sep 45 put option for 70 cents or better. The max reward is limited to the initial 70 cents received and will be captured provided NUE remains above $45.

To minimize the risk, you could exit if NUE falls below the strike price of $45.

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

Article printed from InvestorPlace Media,

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