Trade Update – Closing $CAT July / Aug 85 Put Spread for Gain

by CC July 19, 2013 3:28 pm • Commentary

We placed a bet on CAT a week ago (below) where we wanted to position ourselves for continued weakness into its earnings event on July 24th. We gotten that weakness, with a little help from Jim Chanos (also below) and since the stock is sitting near the support of its 50 day moving average we wanted to book the profits of this structure and look to re-visit the name before the 24th.

Action – Sold to close CAT (85.60) July/Aug 85 put calendar at 1.90 for a 0.65 profit




Considering Our Options – $CAT July / Aug 85 Put Spread

Jim Chanos just hit the tape with his latest “Pick to Click”, Short CAT. Here’s the rundown from  Business Insider:

And the famed short-seller’s next victim is… Catterpillar Inc.

WHY? The global commodities super cycle is over, China is slowing down, and Catterpillar is “in the wrong business at the wrong time.”

Dan laid out his bearish thesis in CAT on this past Friday’s Options Action. Here’s the video:

So the bearish calendar spread has a nice set-up into expiration. The best case scenario would be for to CAT to continue its move lower down towards the 85 strike. $85.43 is the 50 day moving average and could act as support on a move lower from here.  July volatility spiked after the Chanos headline but with only a few days until expiration, that premium will quickly go to parity.

So what we’ll look to do is if we get a great setup into Friday’s close where the stock is down near the 85 strike, we may just take off the entire trade for a nice profit. If the stock goes sideways from here into expiration we may look to spread the August options and hold onto the bearish thesis as we think low 80’s in the stock over the next month or 2 isn’t out of the question.  CAT reports Q2 earnings before the open on July 24th.



Original Trade:  New Trade – $CAT Nip

3:03 pm EDT – July 12, 2013 By and

Caterpillar has been our go-to name to play Chinese weakness.  All those empty cities are meaningful as a broader sign of overcapacity, corroborated more recently by the weakness in global commodity prices as well as emerging market equities.

The fundamentals haven’t changed since our last CAT trade a couple months ago.  CAT reports earnings on the morning of July 24th, and based on the price action and commentary from Chinese policymakers in the last couple months, business has likely gotten worse not better, especially internationally.  CAT only gets 35% of its revenues from North America, so it’s likely been especially impacted by international weakness (as well as dollar strength).

Sure, some bad news is already priced in, as CAT trades at 13x expected 2013 earnings, but only 11x 2014 estimates.  However, from 2012 to 2013, its earnings are expected to decline 20%, so analysts are basing a good bit of their optimism (17 buys, 9 holds, 1 sell) on the idea that CAT’s business is at a trough, and will turn around in the coming year.

But even on the recent market rally to a record close in the S&P 500 index, Chinese stocks (as measured by the FXI) have not even been able to make it back up to their 50 day moving average:

FXI 2 year daily chart, 50 day ma in pink,  from Bloomberg
FXI 2 year daily chart, 50 day ma in pink, from Bloomberg

China has been THE driver of CAT’s mining business globally (China has consumed 30-70% of most globally traded commodities in the last 5 years), and also a major contributor to revenue growth in the machinery and power systems segments.  So Chinese weakness means no turnaround for CAT in 2014, and more estimate cuts going forward.

Not surprisingly, CAT’s chart looks a lot like FXI.  As a diversified U.S. multinational, it has showed a bit more strength, but a major market laggard nonetheless.  CAT stock has rallied along with the broader market in the past 3 weeks, all the way back up to near its 200 day moving average:

CAT 2 yr chart, 200 day ma in black, Courtesy of Bloomberg
CAT 2 yr chart, 200 day ma in black, Courtesy of Bloomberg

CAT broke its steep uptrend in mid-2011, at the same time that emerging market equities topped out.  Since then, CAT has made a series of lows around $80 (white line), but each subsequent bounce has been weaker and weaker.  With the market near all-time highs, this month’s bounce hasn’t even been able to reach the 200 day ma.

Add it all up, and July’s earnings report from CAT is likely going to paint more weakness.  If true, then our expectation is that either the stock sells off into the report as traders anticipate another dud (that has been the trend over the past few quarters), or the stock actually sells off on the actual report.  $80 is still stout support, but a move down to there from the stock’s current level makes sense.

TRADE: CAT ($87.25) Bought July / Aug 85 Put Spread for 1.25

-Sold 1 July 85 Put at .35

-Bought 1 Aug 85 Put for 1.60

Break-Even on July Expiration: 

The ideal spot for this stock at July expiration (next Friday) is 85, or ~2% lower, at which point the short July 85 put will be at zero and the Aug 85 put will still be bid. Before then the structure is slightly bearish (~15 deltas) with 85 still acting as the ideal spot, but even without much movement the structure will benefit from July weekly decaying quickly with August remaining bid into the July 24 earnings event.  The main risk is a move above 88.50 or below 83.50 before next Friday.

Risk Chart:

Screen Shot 2013-07-12 at 12.41.52 PM
from ThinkOrSwim


Trade Rationale:  I want to finance the purchase of downside puts for the earnings event, and will look to once again next week close to expiration sell the July 26th weekly 85 puts against the Aug that I own, or if the stock is close to 85 I will look to sell a lower strike put in Aug and stay long a vertical call spread into earnings.