Alcoa Corp Stock Dips Are Perfect Opportunities for Bulls — Go Long
Coming into its earnings report, Alcoa Corp (NYSE:AA) was up 70% year-to-date. This made for a precariously perched stock. Such situations create rising wedges that if broken could carry downside momentum. However, AA stock has been tested before and the bulls have prevailed. I believe that they will again on this dip.
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This morning, traders are punishing it down 3% in after hour trading on its earnings report.
AA stock is up 112% in 12 months, so a small dip is normal. If the equity markets were not so bullish, I’d be scared of buying dips too soon. But so far, Wall Street refuses to let the bears have any days of glory.
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In such an uber-bullish macro economic situation, I want to capitalize on today’s fear in Alcoa stock. My bet is that the recent proven support will continue to hold through 2017 and into early 2018. I think that the variables that are encouraging bulls will remain in place for months to come.
Fundamentally, AA is not cheap. It has a price-to-earnings ratio of 60. This is too high in relative terms to its competitors and, in absolute terms, to the rest of the market. For perspective, Apple Inc. (NASDAQ:AAPL) has a P/E that is only 19X. Alphabet Inc’s (NASDAQ:GOOG, NASDAQ:GOOGL) P/E is 37. And those two giants are massively profitable companies with rosy futures.
Having said that, AA only sells at a price-to-book ratio of 1.5X. So owning shares at a discount is not likely to be a major mistake. This is crucial to my style of trading. I am confident that if price goes against my trade, I will successfully manage my ownership of Alcoa stock.
Technically, the $45/$46 zone is pivotal. It was the resistance from which bulls broke out in September. Those tend to become forward support. If the selloff brings AA stock to it, both bulls and bears will want to win. So they fight hard for it, thereby creating a stall.
Today, I want to catch this falling knife and I know it could be early. But in my style of trading, I don’t chase upside targets, so I can be slightly imperfect in my timing. I use options where I can build a buffer zone.
Bottom Line on AA Stock
Expectations on Wall Street are somewhat muted for Alcoa stock. It is now trading 15% below the average price target. Furthermore, there is much more room above than below inside the analyst price range for the stock, so there could be a upside surprise there.
However, there is the flip-side risk that some analysts will revise down their ranges if price fails to recover soon.
The Trade: Sell the AA Jan 2018 $40 Put for $1.25. This is a bullish trade that has an 80% theoretical chance of success. Otherwise, I will accrue losses below $38.75.
Selling naked puts carries big risk. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the AA Jan $40/$38 bull put spread, which will yield 15% on risk. Neither setup requires a rally to win. AA stock can fall 15% and I can still retain maximum gains.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.
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