Option Traders See Promise in Battered AK Steel

Continued dour share-price action in steelmakers follows a rising consensus of expectation of a long, drawn-out recession (or worse) in the U.S. Amid yesterday's cascade of 52-week lows in commodity (and other) stocks, even the World Steel Association succumbed to the uncertainty, delaying its 2009 forecast for steel companies.

With that in mind, we're interested in the action taking place today in AK Steel(AKS Quote - Cramer on AKS - Stock Picks), which derives 100% of its revenue from the production of steel, 86% of it from the U.S. (per 2007 figures). Shares are down 3.6% today at $17.44, indicative of a year that has seen the company give up some 62% of its value. And with implied volatility at 52-week highs (178% vs. 136% historic volatility), it's clear that the option market en masse feels that the uncertainty surrounding steelmakers justifies a higher price for call and put protection.

Today's volume, however, tells a somewhat different story. Evidence of fresh 1-by-2 call spreads in the November contract between strikes 20 and 25 suggests that some traders are positioning for a bounce back from the lows into the month of November. This ratio call spread involves the sale of twice as many higher-strike calls as purchased lower-strike ones; this helps the trader control costs and also resolutely caps any upside.

By selling two 25-strike calls for $1.65 apiece and buying one 20-strike call for $3.50, the AK Steel trader limited the initial debit on the trade to 20 cents. He or she also raised the risk stakes somewhat, as half of the higher-strike call position is an uncovered short, leaving him or her vulnerable to exercise in the event of a dramatic move to the upside. At present, the options market is priced to reflect a slightly better than 1-in-3 chance of that 25-strike call landing in the money by Nov. 21.

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