Caterpillar Inc. (NYSE:CAT) took a page from the Boeing Co (NYSE:BA) book and it has shrugged off every dip since May 2017. CAT stock came into its earnings event up 65% since then and it’s adding a bunch more this morning.
The stock rose 105% on the Donald Trump rally, which just kicked into over-drive. The new Tax law spurred a wave of corporate investing in U.S. employees and infrastructure and therein lies even more support in CAT stock.
The reason for this morning’s jump is a plain old fashioned earnings beat and raise. Management over-delivered on their promises for the past quarter and called for even better things to come. So bears are running out of reasons why they should short CAT stock. This makes the upside trajectory easier than down and I want to profit from it once again.
How to Trade CAT Stock
Today’s setup is a rinse-and-repeat for me. I’ve shared several trades that profited from betting on support in CAT stock. I prefer this method to buying the shares outright. Momentum stocks like this rise so fast that they make it difficult to buy and hold as they always seem ready to correct.
Another reason I need to leave room for error when investing in Caterpillar stock is valuation. With a three-digit price-to-earnings ratio it’s not cheap. So a lot of expectations are already priced in and its bottom line is iffy at best. Compare it to Cummins Inc. (NYSE:CMI) or Deere & Company (NYSE:DE), which have price-to-earnings ratios of 19 and 25, respectively, and better margins.
Yes, this is a very bullish macroeconomic environment for building equipment and services, but I still worry about unforeseen issues that could arise. So I will use CAT options where I can build a moat around my risk.
On the positive side, and with the CAT stock spike this morning, I bet that analysts will need to raise their price targets on Wall Street. It is now trading too close to the upper end of the range.
Furthermore, most of the experts have been in a holding pattern so they may also need to upgrade that as well. I doubt that many of them will take an uber positive note from management as a sign to downgrade.
The bottom line is that the new tax law kicked this expansion period into over drive and CAT management told us things were great in the past quarter and even better going forward. So I want to bet on support to profit from this.
The Trade: Sell the CAT Aug $135 naked put. This is a bullish trade where I collect $2.50 to open. Here, I have 85% theoretical odds of success. But if the price falls below my strike, then I accrue losses below $132.50-per-share.
Selling naked puts carries big risk, especially for a stock as expensive as this. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the CAT Aug $135/$130 bull put spread, where there is the same odds of winning. Then the spread would yield 10% on risk.
It is important to note that today’s trade doesn’t need a rally to profit. I simply need support for CAT stock to hold for the near-term. Time will do the rest and chip away at the premium in my favor.
Ultimately, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get Nicolas Chahine’s newsletter for free here. He 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.
