While the 2016 U.S. election results caused a huge rip in steel stocks, 2017 has been awful to them. For example, AK Steel Holding Corporation (NYSE:AKS) stock fell over 50% since January.
This has been a sector-wide problem, not one specific to AKS. However, it is lagging its competition. United States Steel Corporation (NYSE:X) is only down half as much, and Nucor Corporation (NYSE:NUE) is down just 2% on the year.
The valuation is not really the issue here. These are cheap stocks from a price-to-earnings perspective but things are not as simple as that. Steel companies have to contend with overseas competition, which often plays unfairly.
Of these three, AKS is the cheapest but doesn’t pay a dividend. In a rising rate cycle, this disadvantage fades a bit.
It is ironic that NUE is the most expensive yet is the one whose stock has performed best.
Click to Enlarge Coming into its earnings report, AK Steel stock fell 3% to the bottom of the price range on Wall Street. Now that they reported earnings the selling continues down another 13%. Technically, it has held over $5 per share even on heavy recent tests. This is a good sign that it will continue to hold. All those who wanted to sell may have already sold.
But on a weekly chart, I can see that if we fail to hold AKS recent support then the long-term range downside potential is much lower. $4.50 per share would be one level of contention, then $4. In January of 2016, it fell to $2 per share, so it being a low-priced stock doesn’t mean it can’t get cheaper.
The experts are on hold, with no clear directional opinion. So today’s trade is purely based on the recent price action not valuation. I consider this a speculative trade in a conservative portfolio. I am betting that the recent support should hold through the next few months. If so, I will generate income with no out-of-pocket expenses. This is a long-term bet on AKS which needs the global reflation thesis to continue through next year.
Specific to this case, the last three earnings reports previous to this one were badly received by investors. This one so far seems to be par for the course. Except for that of last October, the initial earnings dip did not mark the bottom of the swing low but AKS steel stock started out from higher levels. Convention suggests that I should wait three days before catching it. But since I am using options I am willing to jump the gun.
AKS Stock Trade Idea
The Bet — Emphasis on “Bet”: Sell AKS Jan 2019 $4 put where I have only a 75% theoretical chance of gaining 60 cents per contract. But it price falls below my strike price then I will amass losses below $3.40.
Selling naked puts carries risk and although it’s not huge, there are those who want to mitigate it. They can sell a spread instead.
The Alternate Bet: Sell the AKS Jan 2019 $4/$3 credit put spread where I have about the same odds of winning. Then the spread will deliver 30% in yield.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.