Trade Update $CMI – Close to 110 Target, Taking Gains

by Enis March 26, 2013 1:46 pm • Commentary

Trade Update  March 26th, 2013, 1:46 pm:  CMI is down about 6% in the past 2 weeks, since I initiated the put fly due to commodity and Chinese weakness.  That’s an especially big move considering that the SPX is flat during that time.  I had targeted the 110 support level with my trade structure, and now that we’re close to that important level, I’m going to take my profits on that trade.  In short, I don’t think the stock stays around 110 for long.  It either bounces again off support, or blows through it, so I’ll take my profits here.

Action: Sold the CMI ($112.68) Apr 120 / 110 / 100 Put Fly at $4.85 for a $2.00 gain

Original Post March 12th, 2013:  The Little Engine That Could

Cummins stock has been on a tear ever since the stock reduced its guidance in early October, a good example of bad news already priced into a stock.  Here is the 1 year chart showing the 30%+ rally from there:

CMI 1 year chart, Courtesy of Bloomberg
CMI 1 year chart, Courtesy of Bloomberg


I’ve circled that lowered guidance date on the chart.  The stock zoomed higher from there and never looked back.  However, there are several signs on the chart signaling that a turn might finally be in order:

  1. CMI has not been able to breach the 120 level on the upside in the past month, even as the broader market has made new highs
  2. The RSI, shown in the lower panel, shows declining momentum over the past month, even as CMI stock is essentially unchanged.
  3. The stock almost touched its 110 level of support on the selloff in Feb, which is close to where it started the year.

The 110 level is obvious support, and 100 is longer-term support, where the 200 day moving average (shown in black) comes into play.

But what of the fundamentals?  Certainly, the fundamental backdrop for CMI has improved, with their most recent earnings release citing the strength in North America for a bit more optimism in the executive suite.  But CMI’s earnings are still expected to only grow 2% in 2013 (and still below calendar year 2011), so investors in CMI today are paying for the 2014-2015 story.  Against that, global growth is obviously slowing.  Here is a chart of JPM Global Manufacturing PMI over the last 15 years:

15 year chart of JPM Global Manufacturing PMI, Courtesy of Bloomberg
15 year chart of JPM Global Manufacturing PMI, Courtesy of Bloomberg

The chart has spent most of the time in expansion mode, above the red line at 50.  But current growth is obviously tepid from a historical perspective.  CMI still gets more than half of its revenues from outside the U.S., and its flat revenue situation over the past 2 years reflects the global manufacturing downturn.

I traded CMI from the short side on 3 occasions last year, here, here, and here, and ended up down small for the trouble.  The fundamentals haven’t improved much, but the stock price has boomed, so I’m revisiting this old friend.

Finally, Chinese data has continued to disappoint, and the Chinese equity markets are only up 1% this year, one of the weakest regions globally.  CMI only gets 7% of its revenues from China directly, but Chinese data has been a harbinger of the trends in the global manufacturing cycle as a whole.  The broad trend is not in CMI’s favor.

The reason I started out the post focusing on the technicals is because the fundamental backdrop for CMI has not changed much in the past 6 months.  What’s changed is the sentiment and psychology surrounding the industrial sector in the U.S.  However, the technicals suggest that the improved psychology is nearing a turning point, and the risk/reward of a bearish entry here makes sense:

Trade: CMI (117.90) Bought the Apr 120/110/100 put fly for 2.85
  • Bought 1 Apr 120 put for 4.65
  • Sold 2 Apr 110 puts at 1.05 each (for total of 2.10)
  • Bought 1 April 100 put for 0.30

Break evens on April Expiration:
-Losses above 117.15 and below 102.85. Max loss at or above 120 and at or below 100.

-Profits up to 7.15 between 102.85 and 117.15 with max gain of 7.15 at 110.

Trade Rationale:
I think CMI is due for a pullback and the Fly strategy allows me a decent range  of profitability to the downside.  The 5- day moving average in the stock is just below 115 and the 200 day will provide lots of support at 100 on any sell-off.  Because the fly is already in-the-money my premium risk is minimized as the structure is intrinsically worth just over 2 dollars, so the real risk is short delta to the upside here and any massive sell-off which is a lot less likely.