It is that time of year again; with earnings season under way.
It is an exciting time for investors, as with each passing day
more and more companies post results of their most recent
A good earnings report can send stocks soaring, while
worse-than-expected results can lead to sharp declines in share
In the past, there was a great amount of attention paid to
reports from aluminum maker Alcoa (
). Since aluminum is used in such a wide array of products, Alcoa
was viewed as the best bellwether stock for the overall
Weak aluminum prices in recent years rocked the entire
aluminum industry, with Alcoa being no exception. Aluminum
producers have tried their best to support prices through
production cuts, and while there are signs that things are
improving, the sector as a whole is still pretty weak. So much so
that Alcoa was actually removed from the Dow Jones Industrial
Average in 2013.
But that is not to say we should no longer pay attention to
what Alcoa is telling us. Alcoa reported its fourth quarter
results on January 10, posting earnings of $0.04 per share.
Analysts had forecast Alcoa to earn $0.06 per share.
The stock was trading at its 52-week high the day prior to the
earnings news, but dropped 5% on the day of the announcement.
Another basic materials company that has already posted its
earnings is Monsanto (
). Monsanto is in the agricultural materials business, and it
reported its fiscal first quarter results on January 9, and
actually surprised Wall Street with a better than expected
Going into the report, analysts had forecast earnings of $0.64
per share, but actual results were much better at $0.69. While
the earnings numbers were upbeat, its forward guidance was below
analyst expectations. The company stated that full year earnings
would fall in a range between $5.00 and $5.20 a share, lower than
the $5.25 analysts expected.
Due to the weaker than expected forecast, the stock hit
selling pressure following the report.
What this is telling me, is that the current earnings season
may not turn out too well for the overall materials sector.
However, just because I see weakness, it does not mean that there
is not a way to profit from the expected weakness.
Even in a down market, smart traders are able to turn a
profit. I would not want to bet against any one particular stock,
but I think a reasonable way to play expected weakness in the
overall materials sector is with a bearish hedged trade on
Materials Select Sector SPDR (
XLB is a great way to place the expected weakness in materials
because it is so widely diversified that you will not get burned
if a couple of the companies actually post much stronger than
expected numbers. We can hedge the trade in such a way that even
if we are wrong, and the materials sector does trend higher over
the next few months, that our investment will be protected.
A nice bearish hedged trade on XLB would be the March 48/51
bear call credit spread. In this trade you would sell the March
48 call while buying the same number of March 51 calls for a
credit of 20 cents This trade has a target return of 7.1%, which
is 36.7% on an annualized basis (for comparison purposes only).
With XLB currently trading at $45.57, the trade has 5.8% downside