Considering Our Options – $CAT Nip

by CC June 29, 2015 2:45 pm • Education

A couple weeks back we entered a trade in Caterpillar (CAT) with the idea that we could fade a recent bounce to resistance while financing a bearish earnings trade in August expiration. Here was the trade from June 11th:

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

The stock is down a few dollars since then and is now approaching our strike so it’s a good time to check in and see how it’s going and what we’re looking for next.

Today, with the stock at 85.35 this trade is worth about 1.20. Since we paid 1.10 this is nothing to write home about despite the stock being down nearly 3 dollars since the trade. The reason for that underperformance versus what one would expect is due to the rise in implied volatility which has been outsized in July, particularly today. Here’s the past 6 months IV30 (in red):

[caption id="attachment_54918" align="aligncenter" width="686"]Screen Shot 2015-06-29 at 12.34.52 PM from LiveVol Pro[/caption]

What that has done to the trade is price in greater theoretical movement in the stock over the next few weeks until July expiration. And since the trade is essentially a range trade for profit and loss into July expiration that delays the decay in the July put we are short and pushed out any profits from the stock being near our strike.

But that’s no big deal. We have the stock where we want it and the only real risk here is a market follow through or bounce strong enough to the put the 85 strike in the rear view mirror. Ideally it trades within a dollar or 2 of this strike over the next few weeks and we’ll be well positioned to roll the trade into an August vertical from a position of profits or even take it off entirely if those profits are great enough.

Right now the deltas are basically even. The theta (decay) is also insignificant at this point at about 1c a day. So we’re basically just looking at a situation where the longer the stock stays near 85 over the next days and weeks the better. And if that were to happen the profits would accelerate because that would probably mean implied volatility would stop going up.