I’ve played CMI twice in the past 2 months, both bearish bets. The first I closed as a nice winner, and the second I closed for essentially flat.
My longstanding thesis has been that CMI is overly exposed to international growth, particularly related to the BRIC infrastructure story. On its most recent earnings report, CMI actually mentioned U.S. weakness in addition to international weakness, and provided weak guidance for the next 6 months.
But sentiment had apparently become too negative. CMI is actually up almost 20% from its lows after its negative pre-announcement in early October. The bulls would argue that the incremental positive is the improvement in China. Certainly, the Hang Seng or FXI have shown optimistic price action, and the change in leadership has offered signs of reform.
Yet, look at the chart of Chinese Manufacturing PMI over the last 6 years:
Not exactly a picture of strength over the last year. The bulls expect an imminent move higher with the new government. I’m more skeptical that these policymakers can generate that growth at will, given the existing massive imbalances in fixed investment.
Regardless, CMI’s recent rally offers a great entry in the case that the hopes and expectations don’t match the reality that management has outlined for 2 straight quarters. Even analyst expectations are only for 5% earnings growth next year, which is on the optimistic side. The stock feels like a case of sentiment turning far too early, much before any fundamental signs of bottoming.
As such, I’m going to get involved again on CMI. This time, I’m actually going to buy a put spread, as the potential downside in CMI in my view is much higher with the stock above $100.
TRADE: CMI ($101.75) Bought to Open the Jan13 97.50 / 90 Put Spread for $1.54
- Bought 1 Jan13 97.50 put for 2.29
- Sold 1 Jan13 90 put at 0.75
Break-Even on Jan13 Expiration:
- Profits btwn 95.96 and 90.00, with max profit of $5.96 below 90.00
- Losses btwn 95.96 and 97.50, with max loss of $1.54 above 97.50
TRADE RATIONALE:
Today’s 5% rally in the stock feels like a gift, as CMI has moved back up to its 200 day ma, which has acted as resistance twice before in the second half of this year. The 85-90 area is obvious support in the stock, which is why I chose those strikes. Since this trade is not dependent on earnings, but rather a change in sentiment, I chose Jan13 expiry, which won’t capture earnings (CMI reports late Jan/early Feb). The 4 to 1 risk/reward is a good proposition on a stock that seems up on fumes to me.