U.S. Steel’s Trade Gore, Not Good or Easy to Win

by Dan October 25, 2019 12:50 pm • Trade Ideas

On March 2nd, 2018, president trump famously stated that “trade wars are good and easy to win” and proceeded to impose a 25% tariff on steel imports and a 10% tariff on aluminum imports (including those from our allies). At the time, shares of U.S. Steel (X) were trading just below $48, threatening a breakout to multi-year highs:

I suspect X’s management disagrees with trump about how good and how easy it is to win trade wars, as their earnings in 2019 are expected to drop by 97% from 2018 on just a 9% year over year expected sales decline:

Shares of X are down a whopping 75% from 2018 highs, desperately trying to find a bottom, bouncing off of $10 more than a handful of times over the last two months. It is also worth noting that the stock is now above the downtrend that has been in place from the highs:

It’s fairly interesting to me that the apparent truce in the trade war with China, which really means the pushout of previously threatened tariffs has caused the S&P 500 (SPX) to make march back towards the prior highs, something we have seen for the same reasons on a few occasions over the last 18 months, and in doing so has caused investors to look at some beaten-down groups like industrials with some of the hardest-hit stocks like Caterpillar (CAT) to come up off of the mat a bit. But Material stocks like X, despite its very poor performance (down 35% on the year), high short interest (33%) and horrendous sentiment from sell-side analysts (2 Buys, 8 Holds & 6 Sells) that the stock can barely get going.

So what’s the trade?

On Thursday, Oct 31st X will report its Q3 results. The options market is implying about an 8% one-day post-earnings move, which is basically inline with the average one-day post-earnings move over the last four quarters. With the stock at $11.70, the Nov 1st weekly 11.50 straddle (the call premium + the put premium) is offered art about $1, if you bought that, and thus the implied weekly movement (most of which is for the day following earnings) then you would need a rally above $12.50, or a decline below $10.50 to make money by next Friday’s close. But if you were looking to pick a direction, and define your risk you would merely buy the at or near the money call or put.

Let’s assume you thought that the slightest bit of optimism on the X call next week could cause a short squeeze, you could buy the X Nov 1st weekly 12 call for 43 cents (vs stock $11.72). This trade risks 3.7% of the stock price, offers a break-even up 6% at $12.43 and does not limit profit potential or the Nov 15th 12 call for 58 cents with a break-even at $12.58, up 7.5%, but allowing for two more weeks for the trade to play out as the weeklies are quite binary, get the direction wrong and the trade is a total loser.

If you were inclined to play for a more sustained rally you might consider a call spread in Dec, vs $11.72 you could buy the Dec 12 – 15 call spread for 75 cents. This trade breaks-even up at $12.75, up 8.8% and offers profit potential of up to $2.25, or 3x the premium at risk if the stock is $15 or higher on Dec expiration.

On the flip side if you think the company will miss and guide down again and the next test of $10 to the downside could open the flood gates than I might consider buying the Nov 15th 11.50 put for 67 cents, which breaks even at $10.83, down 7.5% from the current level.

Despite elevated options prices into the print it makes sense to define one’s risk if looking to be contrarian (bullish), despite very poor sentiment and its oversold condition, the 5-year chart below shows an air pocket below $10 down to the 2016 lows near $6.15: