Stock Options To The Rescue! Alcoa (AA)

| July 12, 2012 | 0 Comments

Alocoa (AA) OptionsToday we’re going to look at a stock replacement strategy on Alcoa (AA).  It allows you to reduce your risk and gives you upside potential. 

Here’s what happened…

Alcoa shares have slumped 6% from $8.75 to $8.25 after they kicked off earnings season on Monday. 

Here’s the deal…

AA’s revenue and earnings came in ahead of Wall Street estimates.

The aluminum maker reported quarterly earnings of $0.06 per share.  It was a penny better than the 5 cents they were expected to make. 

The better than expected results were fueled by growing demand for aluminum.  But the strong demand was offset by falling aluminum prices.   

Here’s the kicker…

AA’s quarterly results came in better than expected.  But it still wasn’t a good quarter by any stretch of the imagination.

Analysts had drastically slashed AA’s earnings estimates in the weeks leading up to the report.  And they still only managed to beat estimates by a penny.

Don’t forget, AA’s revenue and earnings will always be tied to the price of aluminum.  And right now Chinese companies are flooding the market with cheap aluminum. 

As a result, aluminum prices are down 18% over the last year. 

The good news is aluminum demand is growing.  AA is expecting strong demand from automakers and aerospace this year.  And they reaffirmed their projection that demand will grow 7% this year.

Clearly, falling prices of aluminum are AA’s biggest headwind at the moment.  And that’s in large part a function of investors’ expectations of slowing economic growth.

If those fears prove to be overblown, growth expectations could rebound quickly and so will aluminum prices.

Here’s what to do now…

Obviously, anyone who bought the stock before earnings has seen the stock move against them.  Instead of holding onto the stock in hopes of a rebound, replace your stock holdings with a call option.

Let’s assume you bought 100 shares of AA at $8.75 before earnings. At a recent price of $8.25, you’re sitting on a 6% loss. 

Selling AA and buying the AA January 2013 $9 call option for $0.56 will reduce your risk and give you upside potential if AA rebounds later this year.

Right now you can sell your AA stock for $8.25 per share, a loss of $50.  And it will cost you $56 to buy one January 2013 $9 call option.

If the global economy doesn’t rebound, it could get really ugly for AA.  The stock could easily fall to around $6 per share.  And you could be sitting on a $275 or 30% loss on the stock.

This strategy limits your losses to the loss on the sale of the stock plus the cost of the option.  In this case, your losses are capped at $106 or 12%. 

On the flip side, you can recoup your losses and even profit if the global economy and AA rebounds later this year.  

In order for the rescue trade to work, AA needs to close at $10.06 per share by the time these options expire in January.  And if the global economy rebounds, there’s a good chance AA could see $11 per share by January.

As you can see, replacing your AA stock holdings with a call option reduces your risk and still gives you upside if the stock rebounds in second half of the year.

 ***Editor’s Note***  Just as an FYI, my good friend and colleague Gordon Lewis is releasing a new penny stock in his Penny Stock All-Stars portfolio later today.  He tells me this stock is a tiny technical services company that should heat-up as the housing recovery rolls on.  Click here for access to the portfolio before he releases the name of this stock.

Good Investing,

Corey Williams

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Category: Stock Options To The Rescue!

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.