2017 continues to surprise many with the resilience of stocks. This is in spite of scary headlines, which included nuclear war talks and actual missiles flying over Japan. Yet stocks continue to inch up with seemingly no end in sight to this bull rally.
Caterpillar Inc. (NYSE:CAT) is a perfect example of how convicted is the bull of 2017. The stock won’t quit rallying. Even at all-time highs, analysts still upgrade it and stick their necks out on it even further. As they say, you can’t argue with the price action, and Wall Street is acting as if this one is a slam dunk winner.
I am not one to chase rallies this late in the game, but I don’t mind betting on proven support inside the extended rallies. Meaning instead of buying too late, I like to sell downside risk where price is not likely to go. This gives me the opportunity to create bullish profits out of thin air even if CAT stock stalls.
Click to Enlarge Selling puts allows me to build healthy buffers but this doesn’t absolve me from trading fundamentals. CAT has solid management and a business expansion cycle that’s guaranteed thanks to central banks across the globe. Add to it the potential that’s bottled up inside the Donald Trump trade and you’ve got a bullish thesis that would need a black swan event to derail it.
Caterpillar stock is not cheap with triple-digit price-to-earnings, especially when you compare it to Cummins Inc. (NYSE:CMI) or Deere & Company (NYSE:DE) which are under 20. So there is plenty of hopium built into CAT from the ongoing global expansion. This is more proof of an uber-bullish equity market and it will a major change in the macro thesis for it to ease. So far, this is not an impending event.
Today I want to put my risk where my mouth is. No, I won’t chase upside potential, but I want to generate profits with no out-of-pocket expense. I am willing to bet that the put placed by the Trump trade will hold. In other words, I will bet that traders will continue to buy dips in CAT stock.
Technically it’s not ideal to chase rising wedges as steep as the one that exists in CAT, but I believe that I can create a 20% buffer large enough to protect me if price moves against. There are pivotal levels that I can leverage.
CAT Stock Trade Idea
The Trade: Sell CAT Feb 2018 $97.50 put and collect $1 to open. This is a bullish trade that has an 85% theoretical chance of maximum gains. But if the price falls below my strike, then I own the shares and could accrue losses below $96.50.
Selling naked puts is not suitable for all investors. To mitigate some of that risk, I can sell spreads instead. There, the maximum losses become limited by the width of the spread.
The Alternate Trade: Sell CAT Feb 2018 $100/$97.50 credit put spread where I have about the same chances of success. If it wins, the spread delivers 10% yield on risk.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.