New Trade – $CAT Scratch Fever

by CC June 11, 2015 11:56 am • Commentary

A couple of weeks ago we looked at the set-up in Caterpillar (CAT). Here are some highlights:

CAT’s fundamentals remain challenged with greater exposure outside of North America than DE (55% vs 35%), and far greater exposure to emerging markets. To top it off the technical set up for CAT vs DE couldn’t be more stark. While DE is at 52 week highs, and 5% from the five year highs, CAT is in a massive downtrend since making new multi-year highs in mid 2014 and down almost 25% from the highs …

… On a longer term basis, CAT is now approaching a technical danger zone between $85 and $80, and I suspect further weak data from emerging markets, six years into the global recovery could cause a meaningful break below $80 …

… The late 2013, early 2014 strength in CAT can likely be explained away from the company’s aggressive share buyback activity, as early last year they completed a $1.7 billion accelerated buyback and the last summer authorized another ASR that time to the tune of $2.5 billion. Going forward in a potentially higher interest rate environment will company’s be less inclined to issue debt to buyback their own stock??

Despite the stock’s recent decline from $89 to $85 over the last two weeks, the stock feels a tad vulnerable to a retest of $80 in the coming weeks/months.

I am going to wait for a bounce, possibly back to $87

The stock has bounced, and we’ve tried to be patient. We like the set-up even more here with the stock above $88, with $90 serving as potentially staunch technical resistance. In the original post we liked the idea of looking out until August and targeting a move back to the 52 week lows, but we’ve decided that the stock’s bounce provides an opportunity to finance the potential for a breakdown in August following Q2 results in late July.

So here’s the trade:  

TRADE: CAT ($88.25) Buy the July / Aug 85 Put Calendar for $1.10

– Sell 1 July 85 puts at .95

– Buy 1 Aug 85 put for 2.05

Break-evens on July expiration:

– Max profit at $85,  max risk of $1.10 with a sharp move above or below $85

Rationale:  Selling the nearer dated 85 put to helps to finance owning August. In the near term I suspect that a retracement could be in the cards if the stock is rejected at $90.  In July if the 85 puts are nearly worthless we will look to spread August by selling a further downside put and turning the Aug 85 puts into a vertical put spread.