Caterpillar Inc. (NYSE:CAT) has been a Teflon stock. It has consistently shrugged off every bearish thesis for over 18 months. Late in 2014 I too had issues with CAT’s prospects, and early in 2015 I thought I had it right as the stock fell 40% before bottoming in February of 2016.
However, since then the story changed for CAT stock — at least in my view it did. It became clear that the global central banks were completely dedicated to re-inflating the globe by continuously pumping as much money as it will take.
The U.S. is contributing to that with the Donald Trump rally to add fuel to the fire that was already burning. Caterpillar is benefiting tremendously from it. More recently, the sad natural disaster rebuild efforts will also provide a boost to its sales.
Stocks don’t rally this fast completely based on froth. This morning, CAT is setting new highs and it has filled every measured move off its technical breakouts. This makes for an astonishing 120% rally since February of 2016. Mature stocks like CAT are not supposed to do this.
And when they do, it’s usually behind strong fundamentals.
This morning, management delivered a strong earnings beat and Wall Street is loving it. I want to reload with another bullish trade but one that leaves some room for error.
Saying that a stock has good fundamentals is not the same as saying that it’s cheap. CAT’s price-to-earnings ratio is around 800. This makes even Amazon.com, Inc. (NASDAQ:AMZN) look like a bargain. Metrics that are this wacky tend to have special circumstances.
So in this case, I find solace in CAT stock’s price to book, which is under 6. So owning shares at a discount from today is not likely to be a disaster — and therein lies my thesis. I want to generate income from betting on the support in CAT, not so much in the incremental upside potential from this late in the rally.
Click to Enlarge The price targets for Caterpillar stock on Wall Street are tight. It currently trades smack dab in the middle of them. But interestingly enough, most analysts who cover it are not expecting much with their ratings. So this limits the potential of downgrade surprises. If CAT continues to perform then they are likely to revise their prices higher to match reality.
CAT Stock Trade Idea
The Trade: Sell CAT May 2018 $100 naked put for $1. This is a bullish trade which has a 90% theoretical chance of winning. But if the price falls below that level, then I accrue losses below $99.
Selling naked puts carries big risk. The higher the stock price the bigger the margin requirement. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the CAT May 2018 $105/$100 bull put spread where I can yield 13% on risk with about the same odds of success. In neither set up do I need a rally to win. In fact CAT stock can fall 25% from here and I could still retain maximum gains.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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.