Options Watch - Seek Shelter In Commodities
Jocelynn Drake, Option Advisor 07.07.06, 12:30 PM ET
CINCINNATI -
There are times when beauty lies in some of the simplest forms, like a baby's smile at the end of a rough day. For me, it's a trend line. A 50-week trend line, to be exact, which has successfully hemmed in a series of pullbacks for a number of commodity-related issues.
But let's start with a wide view before moving into the nitty-gritty of what's shaking within this outperforming sector.
The commodities sector has enjoyed a stellar rally for more than four years, with massive gains logged by the energy and metals subgroups. The Reuters/Jefferies CRB Index (CR/Y), which is designed to accurately represent a long-only, broadly diversified investment in commodities, has soared an impressive 55% from its March 2003 lows.
Yet what has truly caught my attention with the CR/Y is its most recent pullback. When the market recently tumbled, practically everything came falling from the sky, even the price of gold and oil, which held up so well during other drawdowns. The bears were growling, and options speculators were snapping up puts as if they were at a Midnight Madness sale. CR/Y dropped back to its 50-week moving average and stopped.
This wasn't the first time the index found support at this trend line. In fact, CR/Y had used this intermediate-term trend line as a springboard on a number of occasions since January 2004, and it has yet to finish a week below the 50-week during this period. Furthermore, each pullback to this support level has preceded the index's next upleg.
As any investment adviser or market analyst will be quick to tell you, past performance is not a guarantee of future events. However, the established pattern is a nice starting point for a little digging.
In reviewing my charts, I discovered that Alcoa has developed a pattern similar to CR/Y, and it is now in the process of bouncing off support at its 50-week trend line. It also appears that a number of other investors think the shares are destined to keep climbing, as the stock has seen open interest at its July 32.50 and 35 calls increase. However, Wall Street has yet to fully jump on the security's bandwagon, as nearly half of the analysts following the aluminum producer rate it a "hold," leaving room for potential upgrades.
My only concern with AA is that there is a heavy load of call open interest overhead, which could act as a stumbling block. If you were interested in placing a bullish bet on the shares, I would buy a little extra time in your calls (at least the January series) to allow the equity time to reach long-term resistance at the 40 level.
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Two other commodity-related stocks rebounding off their respective 50-week moving averages are Newmont Mining and Southern Copper. The shares of both mining companies remain in long-term uptrends and are enjoying the gains made in the prices of gold and copper.
However, unlike Alcoa, Newmont is witnessing a spike in put activity. In fact, the security's put/call open interest ratio has been on the rise during the past several trading sessions, as puts are added at a faster rate than calls among its near-term options.
Open interest has exploded since mid-June at the equity's out-of-the-money July 47.50 put to number nearly 26,000 contracts. During the same period, the stock has gained more than 9%. Meanwhile, just for the sake of comparison, peak call open interest in the front-month series reaches only 14,400 contracts (at the July 55 call). From a contrarian perspective, the combination of growing pessimism in the face of technical strength has bullish implications. Newmont's rally still has some room to run.
Turning to the steel sector in this menagerie of commodity-related issues, I discovered one other simple beauty that bears watching: round-number support. In the latest drawdown for both Oregon Steel Mills and Carpenter Technology, neither stock came anywhere close to their respective 50-week moving averages. However, both securities successfully rebounded off round-number support.
Oregon Steel bounced off support at the 40 level, but it is currently struggling with resistance in the 50 region. Traders may want to put this one on the back burner for a while, although a breach of previous resistance in the 54-55 region could indicate that the equity's rally finally has legs to run.
While Carpenter Technology dipped below 100, it managed to keep its weekly closes above this level and its ascending 20-week trend line. Furthermore, investor sentiment currently indicates that the traders are firmly in the bears' camp.
With the market burdened by rising global tensions, inflations fears, Fed rate hikes and hurricane season, commodities and commodity-related issues should continue to represent a "safe haven" for investors amid the chaos.
Jocelynn Drake is a senior editor at Schaeffer's Investment Research. Click here for more options analysis and recommendations in Bernie Schaeffer's Option Advisor.
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