Wednesday, June 12, 2013

MT: Stock Descending a Staircase

Update 7/9/2013: MT broke above its 10-day price channel today and I've closed my bear position in MT for a 3.1% profit in the price of the stock. I structured my position as short vertical option spreads, which produced a 19.4% yield on risk. The options were rolled once during the period I held them.

ArcelorMittal (MT) has been plummeting for a very long time. It peaked at $49.41 in January 2010, and  since then the chart has been a continuing riff on "Nude Descending a Staircase" that would have made Marcel Duchamp proud.

Stripped of its bullish creds (such as they were), MT hit a swing low of $11.15 on April 18, recovered to $13.43 on May 10, and then resumed its descent, breaking below the 20-day price channel on Tuesday and confirming the bear signal today.

If a stock must decline, it should certainly do so with panache, and that goal MT has fulfilled.

Since the most recent leg of the downtrend began  in January, MT has broken out to the downside once, for a 23% yield on a position lasting 58 days.

Since the last major high in May 2011, MT has completed seven bear signals, for an average yield of 7.9% and an average trade duration of 33 days.

This is a bear chart to be proud of.

MT was one of six symbols to survive my initial screening. (See "Wednesday's Prospects" for details.)

Of the two upside breakouts, CI failed confirmation and NFP had a weekly chart containing several huge gaps that was just a bit too prone to surprises for my taste.

Of the remaining downside breakouts, the yield on FFIV's completed signals were lower than what MT provided, MSTR confirmed its breakout but with little conviction, and POWI had insufficient liquidity to support a bear trade, either with options or a short sale of shares.

ArcelorMittal is a multinational steel and iron company based in Luxembourg with an operational headquarters in London and production locations on every continent except Australia and Antarctica. It works in a competitive field, especially in light of China's growing steel industry, and as a raw materials company was hit quite hard by the Great Recession.

Long term, I'd argue that for a multinat of ArcelorMittal's size, the harder the fall, the more spectacular the recovery. But that's long term. Not my playing field.

MT is followed by only a handful of analysts, who collectively give it a 17% enthusiasm index.  That must be based on hope for the future, because the company reports a return on equity of negative 4%, a loss. Debt isn't at a crippling level, but 40% of equity is high enough to impact any recovery plans the company pay have in the pipeline.

ArcelorMittal has reported losses in five of the last 12 quarters, including all of the last three. It has surprised to the upside four times, and to the downside, seven.

Institutions own a mere 3% of shares, and the price is extremely low. It takes only 25 cents in shares to control a dollar in sales.

MT on average trades 5.4 million shares a day, sufficient to support a moderate supply of option strike prices with three- and four-figure open interest. Front-month at-the-money puts have a 1.7% bid/ask spread.

Implied volatility is running at 40%, near the middle of the six-month range. It has been tracking sideways since mid-May.

Options are pricing in confidence that 68.2% of trades will fall between $10.48 and $13.20 over the next month, for a potential gain or loss of 11.5%, and between $11.19 and $12.49 over the next week.

Today's option trading is running heavily toward puts, whose volume is double the 5-day average. Call volume is running at 93% of the average.

The fair-price zone on today's 30-minute chart runs from $11.83 to $11.98, encompassing 68.2% of transactions surrounding the most-traded price, $11.96. The price opened today above the zone but swiftly dropped to the zone floor before bouncing up slightly in the past hour, with two hours to go before the closing bell.

ArcelorMittal next publishes earnings on July 29. The stock goes ex-dividend in August for a quarterly payout yielding 6.75% annualized at today's prices.

Decision for my account: I love the chart, but the low price of the stock, below $12, makes it somewhat difficult to construct a hedged position built from short vertical option spreads. It simply takes a lot of contracts in order to fill the unit, which is nearly double my base amount. 

I did a 10-contract test order, and it filled immediately above the bid but below the ask, which I'll take. A bit later I rounded out the unit with one further order, with also filled immediately.

My post from yesterday, "Position Sizing: The big and the small", discusses the issues associated with hedging low and high priced stocks. MT's price is far from the real extremes, but I can start to see some of the issues appearing even at a $12 price tag.

I've structured the position as a bear call spread expiring in July, short the $12 calls and long the $13 calls. The spread has a potential maximum yield at expiration of 38.9%  and provides a 3% cushion of profitability above the entry price of the stock.

My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

At several points in my analysis I use the number 68.2%. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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