Shares of Caterpillar Inc (CAT) have been on a tear after the company’s Q3 earnings report on Oct. 23, rallying 5% since the announcement.
CAT stock is ripping higher despite reporting earnings and revenues that missed on both the top and bottom line, with EPS of 75 cents falling shy of the 77 cents consensus and revenues of $11 billion coming in well short on analysts forecasts of $11.33 billion.
CAT stock has been up the past five days in a row, with CAT now reaching an overbought condition on a 9-day RSI basis.
On top of the weak earnings report, CAT also had previously lowered guidance on Sept. 23, slashing full-year EPS from $5.00 to $4.60 and lowering 2016 revenue projections by 5%. CAT stock was hammered on the news, trading down to $63 over the following two days. Since that time, CAT stock has gained an impressive 19%, closing above $74.
Overhead resistance looms at the $75.50 level, and with the stock overbought, a period of consolidation or a pullback may be in the offing. As seen in the chart, the previous two instances when CAT stock was this overbought marked significant intermediate-term highs in the CAT stock price.
From a fundamental perspective, CAT stock is now trading at slightly more than 16 times expected 2015 earnings of $4.60. And with revenues expected to fall further next year, it will be difficult to maintain earnings even with cost cuts and stock buybacks. While 16 times is not an overly rich multiple, it certainly isn’t cheap, especially for a company experiencing a revenue recession.
With worldwide growth slowing, especially out of China, CAT will likely continue to struggle with growth as well. I expect the CAT stock price to struggle at these levels, so selling an out-of-the money call spread is a great way to position in the stock.
Using the regular November options, the trade idea is to sell the Nov $77.50 calls and buy the Nov $80 calls for a 40-cent net credit. This allows for about 4% additional cushion to the upside while also having defined risk.
The maximum gain on the trade is the 40 cent net credit received, or $40 per spread. The maximum loss is $210 per spread, with return on risk of 19.05%.
As of this writing, Tim Biggam had no position in the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can e-mail Tim at tbiggam@deltaderivatives.com.
