Trade this Cheap Steel Stock for a Potential 50%-Plus Gain

Resource and Commodity markets have been hit hard with slowdown concerns that we have seen before. The CRB Index basket of commodity prices is down 30% in the last year pricing in what may be unfound worry that global demand will come to a screeching halt.

One stock that has seen a sharp decline is US Steel. It’s currently approaching its 52-week lows at around $18 — a crushing drop from its highs last year at $46 . There’s not much optimism in the stock. It seems the worst-case scenario has been priced into this stock.

A double bottom has formed on a long-term basis around $18 with bullish divergence as the stock made new lower lows but the volatility did not.  This is often the sign of a significant price base.

Bounce Off Steel
Shares of X have dropped 40%+ in three months on an almost straight down move.  A halfway bounce to therecent March peak at $32 and the June $18 lows conservatively targets $25.  That objective is thirty percent above where US Steel is currently trading.

The Options Way: Unlimited Upside Potential with Limited Risk. #-ad_banner-#

An X long call option can provide the staying power in a potential larger trend extension.  More importantly, the maximum risk is the premium paid.



One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.

Choosing an option can sometimes be a daunting task with all of the choices and expirations.  Simply put, traders want to buy a high probability option that has enough time to be right.

The option strike price is the level at which you have the right to buy without any obligation to do so.  In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for a gain or loss.   

There are two rules options traders need to follow to be successful.

Rule One:  Choose an option with 70%-plus probability.  The Delta is a measurement of how well the option reacts to movement in the underlying security.   It is also important to buy options that payoff from only a modest price move.

There is no need to ONLY make money on the all but infrequent long shot price explosions. Good options plays profit from only modest directional moves.

Any trade has a fifty/fifty chance of success.  Buying options ITM options increase that probability.  That Delta also approximates the odds that the option will be In The Money at expiration.

Buying better options are more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot Out Of The Money lottery tickets that rarely ever pay off.   
 
With X trading at $19.15, for example, an In The Money $15 strike option currently has $4.15 in real or intrinsic value.  The remainder of any premium is the time value of the option.

Rule Two: Buy more time until expiration than you may need — at least three to six months for the trade to develop.  Time is an investor’s greatest asset when you have completely limited the exposure risks.  

Traders often buy too little time for the trade to develop.  Nothing is more frustrating than being right but only after the option has expired premature to the market move.

Trade Setup:
I recommend the January 2013 X $15 Call at $6.50 or less. A close in the stock below $18 on a weekly basis or the loss of half of the option premium would trigger an exit.

An option play also has staying power with the ability to ride through ups and downs that would force most stock traders out of the position.  The option also behaves much like the underlying stock with much less money tied up in the investment.  The January 2013 option has over seven months to develop.
 
The maximum loss is limited to the $650 or less paid per option contract. The upside, on the other hand, is unlimited.

The X option trade break is $21.50 at expiration ($15 strike plus $6.50 option premium). That is just a little more than two dollars above US Steel’s current price. If shares hit the initial modest $25 price target above, the option investment would produce at least 50% return on investment.