Metals bulls double down
07/18/17

Some traders are apparently taking a shine to metals after a dull start to the year.

The S&P 500 Metals & Mining Index continued rallying on Monday after finishing its best week since November. That represents a big turn in sentiment from earlier in the year, when concerns about economic growth and inventory gluts hammered prices.

Yesterday options players rolled a bullish bet in industry heavyweight Alcoa (NYSE: AA), just two days before the aluminum giant reports quarterly results. They sold 5,000 August 32 calls for $4.60 and bought twice as many of the August 38 calls for $1.10 and $1.15. Here’s what it seems to mean:

  • Calls fix the price where a security can be bought, so they can ratchet upward in value quickly when shares rally.
  • It looks like they previously owned the 32s. Given that AA has been ripping higher in the last month, they probably came into the session with some hefty gains.
  • The investor rolled about half their capital into the 38s, buying twice as many contracts for one-quarter of the cost. 
  • Every call potentially controls up to 100 shares of AA. They collected $2.3 million from selling the 32s and paid $1.125 million for the 38s. So they took in a net $1.175 million, and have the potential to make even more money if the stock leaps after earnings.
  • For instance, the 38s will almost double in value if AA closes at $40 on expiration. A 13 percent move in the shares to $41 will nearly triple their worth to $3. Don’t forget the trader now owns twice as many options, so will really clean up if those levels are reached.
  • Breakeven on the calls is around $39.125, and the contracts will become worthless if the stock remains below $38. That’s also near a peak on March 1, so Monday’s buyer may be looking for a breakout through that resistance zone.
Alcoa (AA) 6-month chart

Source: OptionsHouse by E*TRADE

AA rose 0.22 percent to $36.40. It’s the second-biggest holding in the S&P Metals and Mining Index behind iron-ore supplier Cliffs Natural Resources (NYSE: CLF).

The benchmark more than doubled in 2016 as it clawed back from multiyear lows. It stalled in the spring as investors skulked over gridlock in Washington, but good news has been hitting fast and furious recently – this time from overseas.

First, there were worries about an iron-ore shortage in Asia.1 Then, inventories of copper showed signs of tightening.2 Then, indicators of global growth accelerated.3 Then, China boosted production of steel while mulling cuts to aluminum capacity.4 Forex moves have also fed the bullish case as the greenback crumbles to 10-month lows, which is good news for metals priced in U.S. dollars.

Overall options volume in AA was about twice the monthly average in AA yesterday, with calls outnumbering puts by a bullish 9-to-1 ratio.

Traders have already made money in the space. November 14 calls in copper giant Freeport-McMoRan (NYSE: FCX) rose more than 30 percent from last week. And AA calls have more than doubled in value since their purchase on June 27.

Bottom line: Metal stocks had a few soft months, but traders are increasing bets on their long-term comeback.

 

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1. Reuters: UPDATE 1-China iron ore soars, lifts steel, as Li speech, data reassure. 6/27/17. Business Insider Australia: Iron ore is suddenly in a bull market. 6/30/17.

2. Reuters: METALS-Copper rebounds as stock build-up halts, Chilean miners to strike. 7/11/17.

3. RTT News: German Economic Upturn To Continue In Q2. 7/13/17. CNBC: China reports 6.9% second-quarter GDP growth on year, topping expectations. 7/17/17.

4. Reuters: BUZZ-Alcoa, aluminum stocks gain on China capacity cut talk. 7/13/17.