The Chart du Jour
Back on March 6th, with Alcoa trading near $38 and Inco trading near $18 (or a ratio of approximately 2.11-1), we recommended a possible spread trade to sell Alcoa and buy Inco. Relative price-earnings ratios seemed to support this, as well as the prospect for a softening U.S. economy putting a damper of aluminum demand for autos, etc.
This spread was slightly in the money until the last half of March when Inco stumbled $3.5 to just under $15. A worried reader with the spread already positioned has quite rightfully written in asking what is to be done.
While we try never to get too stubborn in our views, and there is always a place to cut and run, our view on this spread at this time is to hang in there. The monthly chart above shows the ratio of AA/N going back to 1991. This last spike is unfortunate, but the Fibonacci rhythm of the overall pattern suggests pretty strong resistance around current levels.
Zooming in to a weekly view of the spread in the chart below, we also think that Alcoa's recent outerformance of Inco is likely a final hurrah. Breaking the spread down into it component parts in search of logical stop-loss levels, only if Alcoa goes back above its March 8th 39 37/64's high or Inco below last November's $13 15/16 low would we get more concerned with this spread.
Even when the fundamentals are on your side, the overall market volatility these days easily risks spread trades like this going temporarily awry. One likely needs to give them a bit of breathing space.
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