While stocks were bid up across the board this week, perhaps none were as loved as those connected to commodities and emerging markets. Foremost among the winners was Caterpillar Inc. (CAT).
The heavy equipment stock has suffered tremendously in recent years. From its July 2014 peak of $111.46, it had fallen just shy of 50% before finally snapping back over the past month. Relative weakness has been CAT stock’s watchword for months on end.
Until now, that is.
Caterpillar just scored its strongest rally since its downtrend kicked off. The near-30% pole vault has been sufficient in turning the daily trend higher for the first time in months. What’s more, its long-term descending trendline has been broken. And it’s not just CAT stock’s absolute performance that’s rockin’ — it has also morphed into a leader on a relative basis.
As shown in the bottom panel of the accompanying chart, the relative strength line of CAT just breached a significant trendline and is now in an uptrend for the first time in many moons.
Despite the rousing success of Caterpillar of late, there are a few things worth pointing out that may have the bulls pulling in their horns in the short run.
For starters, CAT stock is significantly overbought. Even the best of stocks can’t run forever without the occasional bout of profit taking. Given its gargantuan gains of late, don’t be surprised to see some backing and filling in the days ahead.
Yet another signal suggesting short-term caution is the descending 200-day moving average looming overhead. Following such an extended rally, it makes all the sense in the world for Caterpillar to encounter resistance in this area.
That said, traders should consider any and all dips in CAT over the coming weeks to be buying opportunities.
CAT Stock Covered Calls Are Juiced
Current holders of CAT stock should capitalize on the recent ascent by selling covered calls. Such a tactic will bring in some income for the month ahead while providing a dollop of downside protection should profit taking bring the stock down a notch or two. Sell the April $75 calls for $1.35 or better, one contract for every 100 shares you own.
By shorting the calls, you obligate yourself to sell your CAT shares at $75 in exchange for being paid the $1.35. Provided CAT remains below $76.35 for the next month the covered call will deliver a superior return to a straight long stock position.
Traders considering bullish trades might want to wait for a pullback, or at least a pause, in the stock. Then consider buying the May $70 calls to participate in any further upside over the coming months.
The risk will be limited to your purchase price, while the reward will be unlimited.
At the time of this writing Tyler Craig had no positions in any of the aforementioned securities.
