Look for Downside After CAT’s Earnings

by Joseph Hargett | October 22, 2013 9:31 am

Look for Downside After CAT’s Earnings

Construction titan and economic bellwether Caterpillar (CAT[1]) has struggled to find its way back following the Great Recession. The company is scheduled to release its third-quarter report ahead of the open Wednesday morning, and despite a struggling global economy, CAT has found ways to bolster its bottom line — mostly by taking advantage of China’s construction-hungry economy, which now accounts for nearly half of Caterpillar’s bottom line.

Let’s preview the report and see if we can uncover a juicy options trade before the big release.

Wall Street is expecting a profit of $1.67 per share from Caterpillar, down sharply from earnings of $2.54 per share in the same quarter last year. What’s more, analyst earnings estimates have fallen during the past 60 days from expectations of $1.74 per share. Revenue is seen sliding 13% year-over-year to $14.32 billion.

Despite the fact that Caterpillar has missed Wall Street’s expectations in the prior three quarters by more than 6%, there are whispers that the company will top the consensus this time around. Specifically, EarningsWhisper.com reports that Caterpillar’s third-quarter earnings whisper number arrives at $1.71 per share — 4 cents better than the mean expectation.

Optimism toward Caterpillar is also prevalent in the brokerage community. For instance, data from Thomson/First Call reveals that 12 of the 23 analysts following CAT rate the shares a “buy” or better, compared to 11 “holds,” and no “sell” ratings. The consensus 12-month price target of $92.18, however, rests a mere 5% above Monday’s close at $87.70, indicating that despite their enthusiasm, most analysts don’t see much upside for CAT in the next 52 weeks.

Options traders appear to have taken a different stance on CAT’s prospects. The bullish sentiment seen in the brokerage community appears to have been replaced with trepidation, with October/November put open interest of 113,266 contracts outnumbering call open interest of 108,698 contracts. The result is a middle-of-the-road put/call open interest ratio of 1.04.

That said, peak open interest in the October/November series resides at the November 90 call strike, totaling 18,711 contracts. Following at a close second is the November 85 put, which sports 17,712 contracts. Other notable strikes include the November 82.50 put, with 15,093 contracts, and the November 60 put, with 14,529 contracts.

Technically speaking, there isn’t much to be excited about when it comes to CAT’s price action. The stock is off 7% so far this year and has spent the better part of 2013 bouncing between support near $80 and resistance near $90. This trading range has narrowed over the past couple of months to the $81-$88 range. Currently, CAT is trading near the top of this range, and its 14-day RSI is hovering just shy of overbought territory.

1022 CAT Chart Look for Downside After CAT's Earnings

Options traders looking to jump into a CAT position ahead of earnings should know that weekly October implieds are pricing in a potential post-earnings move of about 4%. This places the upper bound near $91.32, while the lower bound lies at $84.10. Looking at the chart above, these levels match up with long-term overhead resistance near $90 and potential short-term support near the stock’s 50-day moving average.

Given the stock’s current technical position (nearly overbought and just below resistance), the elevated third-quarter earnings expectations, and the weak global economy, traders might want to consider a November 82.50/90 bear put spread. At the close of trading on Monday, this spread was offered at $2.81, or $281 per pair of contracts. Breakeven lies at $87.19, while a potential profit of $4.69, or $469 per pair of contracts, is possible if CAT closes at or below $82.50 when November options expire.

At the time of publication, Hargett had no positions in the securities mentioned.

Endnotes:
  1. CAT: http://studio-5.financialcontent.com/investplace/quote?Symbol=CAT

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