Today is a day Caterpillar Inc. (NYSE:CAT) shareholders will wish they stayed in bed. CAT stock finished more than 4% lower in response to the sight of federal agents raiding the heavy equipment juggernaut’s offices.
I’m betting the Feds aren’t looking to buy farm equipment. And so are the denizens of the Street. In true shoot-first-and-ask-questions-later fashion, traders are liquidating Caterpillar shares from their portfolios with prejudice.
Despite the damage, CAT stock remained above all significant support levels. So it remains to be seen if today’s decline will morph into a trend-killing breakdown.
Trading volume ran hot all day, with 23 million shares changing hands by day’s end.
Not surprisingly, there was a mad dash into the options pit for protection. Option premiums for downside puts are exploding today as investors scoop up insurance just in case today’s raid is the tip of the iceberg. Implied volatility ripped higher throughout the trading session, ending near a 52-week high.
The action in CAT today presents some attractive trading opportunities for bulls and bears alike. While the fallout to today’s surprising news is impossible to predict, the marketplace is paying you to take risk right now.
Let’s explore two trade ideas: one bull and one bear.
A CAT Stock Trade for Everyone!
Bear: To capitalize on additional selling, consider buying a put spread. By purchasing a near-the-money put and selling a far out-of-the-money put option, we can create a position that exploits the relative expensiveness of downside puts.
Buy the Apr $90/$85 put spread for $1.05 or better.
Consider it a cheap bet that Caterpillar shares remain heavy for the month ahead. The risk is limited to the initial $1.05 debit and will be lost if CAT stock sits above $90 at expiration.
The reward is limited to the distance between strikes minus the net debit, or $3.95, and will be captured if the stock falls below $85 by expiration. With such a large potential reward in the offing, there’s no reason to get greedy here. I suggest taking profits if the put spread rises to $2.10, giving you a 100% return.
Bull: If you think today’s swoon is overblown, then there are numerous ways to exploit the fear.
Consider selling the Apr $85 put options for $1.15.
As long as CAT stock sits above $85 at expiration, the put will expire worthless, allowing you to pocket the $1.15 credit. The puts reside about 10% out-of-the-money, so we’d have to see strong follow-through to today’s drop without any recovery for you to lose money at expiration.
And, if you’re a willing buyer of CAT shares in the $85 region, you could allow assignment if the put sits in-the-money at expiration. You will have to buy 100 shares of stock for each put sold.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
