Bullish Option Ideas For Alcoa And CF Industries

Includes: AA, CF
by: John R. Conway

Despite Apple (OTC:APPL) being down over 2% on Monday April 16, the stock market continued to chug higher, and it looks like Apple's pullback isn't affecting the market as a whole. There has been some sentiment on The Street that a pullback in Apple could drag the market down, but so far this seems to be affecting the Nasdaq and not spreading over to the Dow and the S&P 500.

Currently, I am still bullish on the market and have been since the start of the year. In Q2, there have been some hiccups, but I believe Q2 will be more of a stockpicker's market, as investors could see some short-term selling pressure in high-flying names such as Apple, Google (GOOG) and Priceline (PCLN) (Just to name a few), and rotate into names that are not at 52 week/all-time highs.

When investing, one strategy that investors usually pay attention to are the trends. Following a trend can be seen from many different angles. Some of these angles include a stock that is trading in a technical pattern, bounces off a moving average and positive earnings (just to name a few). Usually a trend will most likely play a part in an investors trading thesis and can help support bullish or bearish sentiment.

When trading a trend that has bullish or bearish sentiment, one way that investors can risk less to make more is through options. When trading options as a cheaper alternative to buying shares, options can be viewed as an arsenal of weapons. Some option strategies can give a big bang for an investor's portfolio if used accurately, and other option strategies are more precise and require patience to get the best shot. Here are two stocks that I am taking a look at and how to play them using options:

Trade #1 Alcoa (AA)

On April 10, 2012 Alcoa gave The Street a positive earnings surprise of 0.10 versus consensus estimates of -0.04. While the beat is considered an earnings surprise, I believe the analysts estimates were too low, and were underestimating this aluminum giant. While the earnings report wasn't stellar, Alcoa reacted the next day after earnings by going up 6%

In Alcoa's Q1 earnings statement, Alcoa reported revenue of 6 billion that was up year to year despite a 9% decline in aluminum prices. In my opinion, Alcoa reported a positive beat on earnings, because Alcoa was able to bring down cost/expenses despite flat sales from last quarter. Alcoa also benefits from weak U.S. dollar and has cash on hand at 1.7 billion.

When looking forward, Alcoa has a consensus estimate at 0.11 for Q2, but this can be subject to change. Q3 and Q4 earnings are expected to rise with Q3 consensus at 0.17 and Q4 at 0.22 Alcoa can be a tricky stock to trade at times due to a high P/E and Beta, and any negative industrial sentiment can send shares of Alcoa tumbling down. For those who have followed me or have seen my posts on SA stock talks, I believe Alcoa is buy under $10 a share. Due to the cyclical nature of Alcoa and sensitivity of aluminum prices, I prefer Alcoa as a trade rather than an investment.

Chart forAlcoa, Inc.

My favorite options weapon is the deep in the money call. For an example of the strategy and how I previously played Alcoa using deep in the money calls, please click here. Alcoa has two nice bounces at the $9.50 level, and both times, the stock went to $10. Fifty cents doesn't seem like a big move, but when trading options, this leverage can be profitable or cheaper than owning shares. For this trade idea, I would want to be patient and see if Alcoa tests or comes close to the $9.50 level. I would also watch the Dow, since If the Dow has a broad-based pullback, most likely Alcoa will follow. Here is a trade idea to consider on a pullback in Alcoa:

Buy Alcoa July 21 2012 $8 Deep In The Money Calls

Cost per contract = 2.15 (2.15 x 100 = $215 per contract)

Breakeven= 8 + 2.15 = 10.15 (current stock price 10.05 - 10.15 = 0.10 move to breakeven) or a 1% upside move.

Delta on July 8 contracts = 0.87

If Alcoa takes a dip and heads towards $9.50, I believe this will be a good buying level for using deep in the money calls as a stock replacement strategy. For investors that believe Alcoa won't head the $9.50 level, I would be a buyer of these contracts at under $2.00 per contract.

Trade # 2 CF Industries (CF)

CF Industries is a chemical manufacturer and distributor of nitrogen and phosphate fertilizer products. CF Industries primarily operates in the U.S. and Canada and has a p/e of 8.29. For those that follow Kevin M. O'Brien, you know that this stock is a favorite of the Daily Option Strategy, due to the large shift in prices that CF industries can have. CF Industries has been trading in a range from $170 to $190 a share over the last three months. Since March, CF Industries has had some nice bounces at the lower end of its bollinger bands, and each time, the stock has had over $8 upside price movements. In the short-term, the $190 level serves as resistance, but CF Industries has an earnings report coming out on May 3, 2012 and heading into earnings the stock could have the potential to break $190. When trading CF Industries one has to pay close attention to the technicals. CF Industries can often trade in an erratic fashion, and I would rather wait to buy the stock on a dip than on a big up day. Buying on the lows is extremely important, and here is how CF Industries has traded when it got near the bottom of its bollinger bands.

Chart forCF Industries Holdings, Inc.

Bounce 1 March 6, 2012 high = $174.75 Low = $168.35 Stock closed at $168.97

Bounce 2 March 29, 2012 high = $182.25 Low = $175.18 Stock closed at $179.50

Bounce 3 April 10, 2012 high = $183.75 Low $178.19 Stock closed at $179.04

If the stock pulls back near the $180 level here is a risk defined option trade to consider on CF Industries.

Buy 180/185 August 2012 vertical call spread

Currently, one could use the May expiration, but after May the next expiration is August. With August you get 123 days till expiration compared to May with 32 days till expiration. Currently the August spread will cost $235 per spread. If CF Industries has a pullback, investors should be able to get a better price close to 2.00 or under. If this spread was placed on Monday, investors would be up $161 per spread, with the stock being up 2.4% If investors are not used to trading CF Industries, I would strongly recommend paper trading the company first before jumping into the pool, due to large price swings.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AA over the next 72 hours.