This Steel Maker Sees Better Days Ahead
Nucor Corp. (NYSE: NUE), America’s largest steelmaker, is calling a bottom in U.S. steel prices.
According to Bloomberg,
“Real demand for our products remains strong in key end-use markets,” Chief Executive Officer John Ferriola said Thursday in Nucor’s second-quarter earnings statement. “We are cautiously optimistic that pricing has bottomed for most products.”
The Charlotte, North Carolina-based company has raised prices for its flat-rolled sheet products twice since June. Customers’ response to the latest hike was “encouraging” and that Nucor expects order volumes to increase in the fourth quarter, Ferriola told analysts during the steelmaker’s earnings call Thursday.
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A turnaround in prices would be a welcome change for the steel industry, considering one core product, hot-rolled coil steel, has fallen about 25% this year. Ferriola said demand in the industry has been hurt by heavy rains in the first half of the year that delayed construction projects and customers clearing bloated inventories.
Still, Nucor said lower prices will weigh on results in its steel-mills segment in the third quarter as prices started to rebound only recently. A recovery in margins will take some time, Ferriola said.
The news seems to have little impact on the stock price. NUE is near the upper edge of resistance on the daily chart that is shown below.
The weekly chart shows the stock is near the middle of a large trading range that has generally defined the price action since late 2016.
Stocks in trading ranges can be tradable, and there are several strategies designed for this type of pattern. However, there are risks, since if the trading range fails to hold there is the strong possibility of a large move in the stock. Being on the wrong side of the break out can be expensive for traders.
Because of the risks, it can be best to use strategies that limit risks and in the case of NUE, an options strategies offers the possibility of a significant short term gain with the additional benefit of strictly defined risks with the maximum risk limited to a precise level in dollar terms at the moment the trade is placed.
A Trade for Short Term Bulls
As with the ownership of any stock, buying NUE could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for NUE
Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For NUE, the August 16 options allow a trader to gain exposure to the stock.
An August 16 $57.50 call option can be bought for about $0.83 and the August 16 $60 call could be sold for about $0.24. This trade would cost $0.59 to open, or $59 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $59.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in NUE the maximum gain is $1.91 ($60 – $57.50= $2.50; $2.50 – $0.59 = $1.91). This represents $191 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $59 to open this trade.
That is a potential gain of about 223% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.