Ah yes…one of the world’s most consumed commodity.
How do you think skyscrapers are built? They are built with steel.
How do you think the entire city of Pittsburg exists? Because of steel.
All of that is great and all, but we care about making money. Maybe we want exposure to steel via the markets because we think steel is going to create a new industry or another Andrew Carnegie is going to come out and change the game.
There are steel futures that trade on the London Metals Exchange (LME), however, there were only 25 contracts traded yesterday so nobody cares. Maybe there is a steel ETF that we can find that gives us the right kind of exposure?
Is There A Legit Steel ETF?
There is a fun little segment for you for all of those science buffs out there.
But enough with the nonsense. We want to make money.
And we want to invest in steel. So is there a product that we can trade that gives us the proper exposure to steel?
Enter SLK, the VanEck Vectors Steel ETF. This ETF is widely accepted as the ETF to trade if we want exposure to steel. While we cannot run a correlation test comparing SLK to anything else, we can see which components make up SLK.
Here we can see the top 10 holdings for SLK. Here is their level of correlation to SLK.
All highly correlated. Looks like SLX is correlated to steel…but we probably already knew that.
Can SLX be the Steel ETF?
While it looks like it is highly correlated to steel, we cannot give it the award of the ETF of choice if we want exposure to steel until we know it has sufficient liquidity. Remember liquidity allows us to trade and invest at any time with any amount at fair market value. If we cannot do that we walk away. In order to do this, we want to check stock volume and options volume.
How is the stock volume in SLX?
It is atrocious. With volume under 100,000 shares per day, the stock bid/ask spread is going to be over $0.10 wide, meaning we will have to take an immediate loss to enter this position. This is something we are not doing. But what about options volume?
Equally as atrocious. And wouldn’t you know, nobody trades options in here because you can drive an Escalade through its markets as it has bid/ask spreads of $0.40. Ew.
While some might call SLX the steel ETF, we need to never get involved in a relationship with it.
What Do We Do if We Want Overall Steel Exposure?
SLX has failed us. But we want overall exposure to steel. So what do we do?
We have to find something that is not only highly correlated to steel (over 75 correlation) but also has sufficient liquidity to trade and invest in a fair market (millions of shares traded, thousands of options).
We can look no further than the top 10 holding of SLX.
We have a few choices to choose from here. don’t we? We have three stock that traded over 10 million shares a day as well as has high 90’s correlations to steel.
Let’s just go from the top. Remember, VALE (Vale S.A) trades roughly 25 million shares in a day and has a 98 correlation to SLX. As long as it has quality options markets, VALE is a reasonable way to have exposure to the overall steel market.
Looking good. Over 50,000 options contracts traded in a day is a large sign of institutional interest. And this is all made possible by small bid/ask spreads in the options markets.
The bid/ask spreads are pennies wide. The volumes are in the hundreds. The open interest is in the thousands.
Another thing that makes trading VALE as a substitute for the overall steel market is the ability to make any type of options trade we would like. Obviously, we can make any type of spread trade that we want, but the barrier to entry for naked options is also quite small. For example, in a normal margin account, selling the $9 naked put would require only $180 in capital requirements.
VALE is the Replacement to the Steel ETF
SLX is not a viable solution for getting broad exposure to the steel market as an ETF. There is never poor liquidity and we do not trade or invest in anything with such a disadvantage as poor liquidity.
On the other hand, VALE has a 98 correlation to steel as well as traded tens of millions of shares a day and tens of thousands of options per day.
Want exposure to steel? Invest in VALE and laugh at anyone who suggests SLX.