2009-03-11

Stocks Option Idea: AK Steel (AKS)

AK Steel (AKS) stands out as 1 of the more vulnerable equities within the steel sector. The stock has underperformed the S&P 500 Index (SPX) by 14% during the past 20 trading days, posting a year-to-date loss of more than 23%. What's more, the equity has plunged more than 85% since February 2008, with overhead resistance at the stock's 10-week and 20-week moving averages forging a path lower for the shares since June 2008. AKS has not closed a week above this dastardly duo during this time frame.

More pressing for AKS investors is the stock's break below the lower rail of its recent trading range. Since mid-December 2008, the equity has trended between support at the 8 level and overhead resistance at the round-number 10 level. Recently, AKS' 20-week trendline crashed through the upper rail of this range, helping to push the security below $8 per share. The next backstop for AKS lies in the 6 region - home to the stock's November 2008 lows.

Despite the equity's technical woes, investors are increasing their expectations that AKS is poised for a rebound. Specifically, options traders have loaded up on calls recently. The stock's Schaeffer's put/call open interest ratio (SOIR) has trended lower in recent weeks, with the current reading of 0.46 indicating that calls more than double puts among near-term options. This ratio also ranks in the lower half of all such readings taken in the past year.

This bullish outlook is underscored by data from the ISE and CBOE. Currently, the ISE/CBOE 10-day call/put volume ratio rests at an impressive 15.06, meaning that 15 calls have been bought to open for every 1 put purchased on these exchanges during the prior 2 weeks. This ratio stands at an annual bullish peak, shedding light on the fact that options traders have not been more call-hungry during this time frame.

Short sellers aren't helping matters, either. During the most recent reporting period, the number of AKS shares sold short rose 14.88% to 7.2 million shares. Despite the surge, it would still take less than 1 day at the stock's average daily trading volume for short sellers to repurchase their bearish bets. Should this short-selling trend gain momentum, we could see additional selling pressure send AKS sharply lower as a result.

To capitalize on an extended decline in the shares, traders should consider an in-the-money (7.50 strike) short-term put option – the March put (premium is 22% of the stock price) or June put (premium is 34% of the stock price) – to take advantage of this opportunity that is attractive from our Expectational Analysis® methodology perspective.

ArcelorMittal (MT)

Another potential bearish play within the steel sector is ArcelorMittal (MT). After shedding more than 85% of its value between June and November 2008, MT entered a trading range between resistance at the 30 level and support in the 22 area. In early February, the shares were once again rejected by overhead resistance at the 30 level, and the resulting sell-off has MT poised for a downside breakout of its trading range. The stock's 10-week and 20-week moving averages have descended into the 25 area, effectively halving the stock's comfort zone, and could potentially create enough pressure to send MT below key support at the 22 level.

Throughout this decline, MT has attracted its fair share of pessimism from investors, but this negativity appears far from letting up. The stock's SOIR of 1.68 ranks above 94% of all those taken during the past year, but data from the ISE and CBOE point toward a continued rise in put open interest. In fact, the ISE/CBOE 10-day put/call volume ratio of 1.14 indicates that puts bought to open have easily outnumbered calls bought to open during the past 2 weeks. This ratio ranks in the upper half of its annual range, pointing toward a rising preference for negatively oriented put options.

Short sellers have also expressed a rising appetite for bearish MT positions. During the most recent reporting period, the number of MT shares sold short rose by 4.6%. However, there is still room for more naysayers to jump on the bandwagon, as a mere 2% of the stock's float is sold short.

Finally, Wall Street analysts have doled out 2 "buys," 2 "holds," and just 1 "sell" on this struggling equity. What's more, Thomson Reuters reports that the stock's average 12-month price target rests at $51.91 per share - a hefty 139% premium to the stock's current trading range. This configuration leaves MT vulnerable to potentially damaging price-target cuts or ratings downgrades.

Olympic Steel (ZEUS)

One final stock of note within the steel sector is Olympic Steel (ZEUS). While the stock's ticker symbol invokes thoughts of godly strength, the shares more closely resemble the fall of Achilles. Since mid-June, ZEUS has fallen more than 81% under resistance at its 10-week and 20-week moving averages. The shares entered a trading range between 22 and 15 in mid-November, but ZEUS's weekly trendlines have narrowed that range considerably in recent weeks. In fact, after battling these moving averages for the past 2 weeks, the shares have finally given up and headed lower for a retest of the 15 level. This support has lost its mettle in recent trading, and ZEUS is now in danger of retesting its November lows near $12 per share.

On the sentiment front, there is a fair amount of pessimism levied against ZEUS. The stock's SOIR of 0.81 ranks above 76% of all those taken during the past year, hinting that options traders have rarely been more bearish toward the shares. However, this indicator should be taken with a grain of salt, as ZEUS is very thinly traded in the options pits.

Among brokerage firms, the stock has garnered a mere 5 analyst rankings, all of which are cautious "holds." The thin coverage and lack of "sell" ratings could have bearish implications for ZEUS. Should the equity be targeted by negative initiations or downgrades from the lingering bulls, the stock could be sent on another downleg in its long-term decline.

This skeptical article notes that the shares of Corning Incorporated (GLW: sentiment, chart, options) have added 30% during the past 3 months, and suggests that investors may be anticipating greater earnings results than the company can deliver. Due to the economic downturn, says the author, Corning is facing uncertain demand and falling prices for its glass display panels. These factors should contribute to anemic profits for GLW, where margins are dependent upon both sales volume and solid pricing on finished goods.

Thanks to the recent run-up in the stock, it's now looking extremely pricey -- its forward price-to-earnings ratio is 17.71, near GLW's median level during the past 5 years. It seems that investors are expecting Corning to buck the remarkably weak consumer environment and continue to rake in strong earnings. This optimism sets the stage for an eventual disappointment, warns this bearish write-up. According to the author, the only time to buy GLW "will be when earnings estimates have bottomed and when earnings have fallen so far that year-over-year earnings growth becomes a virtual certainty."

Contrarian Takeaway:

It's hard to argue with the bearish tone of this piece, considering the technical hurdles facing the stock, and the high hopes evident on Wall Street. Despite GLW's recent rally, as mentioned in the article, the shares have been rejected twice this month by resistance from their descending 120-day moving average. Additional pressure lies close at hand in the form of the equity's 26-week trendline.

However, there's no shortage of optimism on this struggling stock. During the past 10 days, traders on the International Securities Exchange (ISE) have bought to open 2.26 calls for every put on GLW. This ratio ranks in the upper half of its annual range, indicating that speculative investors are feeling surprisingly complacent toward the shares.

Plus, 4 out of the 14 analysts following the stock still consider it worthy of a "strong buy" rating. Any downgrades from these bullish holdouts could spook optimistic investors, potentially sparking a wave of selling pressure on GLW.

Outlook: The Select Sector Homebuilder SPDR (XHB) has come a long way in just a few short months. On Nov. 24, the sector was targeted by a negative cover story in Barron's, titled "Luxury Homes, Discount Prices." Furthermore, on Nov. 26, 2008, Moody's cut its ratings and outlook on D.R. Horton (DHI), KB Home (KBH), Pulte Homes (PHM), and Ryland Group (RYL). It would seem to us that this period, especially the Moody's downgrade, marked a bottom for the sector. However, it appears that some of the sector's strength was attributed to expectations that the housing industry would receive more help in the stimulus package than it actually received. As such, stronger stocks within the group experienced significant pullbacks related to disappointment in the stimulus package. Still, these names are trading near former support areas. In other words, recent price action in this group is not supporting the bullish case as strongly as it was a couple weeks ago.

Crude oil prices have plunged more than 73%, to about $40.03 per barrel, since peaking at $148.35 in early July. However, a recent CNBC survey indicates that 56% of respondents expect the average price of a barrel of oil to be between $50 and $75 for 2009 – a 25% to 87% increase from the current level. Even the financial media is looking for a sharp rebound in the energy sector, as an extremely bullish Barron's cover article from Jan. 26, titled "Big Oil's a Buy," suggested that oil would return to $100 per barrel within a few years. This piece also extolled the virtues of Exxon Mobil (XOM) and Chevron (CVX). Against this backdrop, the Select Sector Energy SPDR (XLE) is off more than 43% during the past 52 weeks. Despite this poor price action, more than 58% of the 1,614 analyst ratings on the oil, oil services, and coal sectors are a "buy" or better, compared to 32% "hold" ratings, and a mere 8.7% "sell" ratings. Finally, the International Securities Exchange (ISE) and the Chicago Board Options Exchange's (CBOE) 50-day buy-to-open put/call ratio for the XLE continues to decline. Downtrends in this ratio have been consistent with poor price action since the mid-2008 top in the sector. Finally, last week's fresh all-time lows for the United States Oil Fund (USO) also do not bode well for the group.

The PowerShares QQQ Trust (QQQQ) broke below former round-number support at the 30 level last week. This region was home to major support from September through November 2008. Furthermore, the ISE/CBOE 50-day put/call ratio for the QQQQ has shown signs of heading lower despite last week's heavy selling pressure. Should this ratio roll over, it would have bearish implications for the technology sector. Finally, the tech-laden Nasdaq Composite (COMP) breached psychological support at the 1,500 last week, with Hewlett-Packard's weak earnings report providing the lodestone for a wave of selling pressure. On the sentiment front, 13 of the 18 analysts covering tech bellwether Microsoft (MSFT) still rate the shares a "buy" or better. Elsewhere, Google (GOOG) has acquired 20 "buys," 2 "holds," and no "sells," and Apple (AAPL) has attracted 16 "buys," 6 "holds," and 1 "sell." Given this mixed outlook, we remain cautiously bearish and will monitor this situation closely during the next few weeks.

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