I had a long-term trade recommendation for Alcoa, Inc. (AA) at the beginning of June. This is what it looked like:
The Options Play
- Buy a January 2013 call with as strike of '9' (priced at $0.86).
- Sell a January 2013 call with a strike of '10' (priced at $0.49).
- Net Debit to Start: $0.37.
- Maximum Profit: $0.63.
Reasoning Behind the Trade
- Alcoa will balance out pricing as it cuts production, and supply and demand equal out.
- The auto industry will increase demand over supply, which will help raise pricing.
I chose the long-term January strike because I was not quite sure when these moves would happen. It appears that my move was right because I am having problems finding anyone who thinks Alcoa will move anywhere soon.
From an Analyst's Viewpoint
BMO Capital Markets downgraded Alcoa recently from Market Perform to an Underperform rating and lowered its price target from $9 to $8. It is far from bullish on the stock. Unless aluminum prices improve, there is little opportunity for a catalyst to make the stock move at all. BMO mentioned the negative performance of Alcoa's upstream operations as I have already written about and takes the position that the prosperous downstream divisions do nothing, but barely keep it in the black
BMO Capital's observations may be right on. It is good to be cautious right now about the whole aluminum industry, which is still over supplied. The problem continues to manifest itself in price as Chinese mills continue to supply aluminum at below-cost levels as opposed to the initial expectations of capacity cuts. On top of this, the European debt situation has squeezed prices to a 2-year low. As long as the Chinese continue to produce like they do instead of cutting production, I do not see how there can be any change in neither the market nor Alcoa's immediate future.
So for those who may not have considered my options trade in June, I have a couple other options I have looked at. Since I think the stock may be moving sideways for a while, one of the things I am looking at is a calendar spread strategy.
Will a Calendar Call Work?
I looked at doing a neutral calendar spread, which involves buying long-term calls and simultaneously writing an equal number of near-month at-the-money or slightly out-of-the-money calls of the same underlying security with the same strike price. Since the stock looks to be running neutral, this seemed like a sensible strategy. My profits would be limited to the premiums collected from the sale of the near month or weekly options minus any time decay of the longer term options. The only problem is that the option prices do not look good enough to make a play like this.
Click to enlarge
Buy a Straight Option
If you look at the chart, you can see the trade zone between 8.2 and 9.0. It is highly likely the stock will climb again to the '9' level in the near future. It has a well-defined peak and valley neutral pattern.
With the relatively low price of the options at present, I would advise buying the following options:
- An October 2012 call with a strike of '9' (priced at $0.26).
The strategy I would use is hold the stock, and as it rises closer to the '9' level, look at a resale as the value of the option increases as it gets closer to the strike point. These option prices are so conservative right now that little is risked in a strategy like this. With the economy the way it is, Alcoa is balanced with aerospace, automotive and transportation sectors growing, while industrial, building and construction demand for aluminum declines. This balance may keep the company in this trading zone through the year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
