Caterpillar Inc. (NYSE:CAT) stock has not been easy to own through the turbulence of the past two months. Tariff war headlines with China made CAT an easy target for shorts. Fears were overblown over retaliation from China. And stocks like Caterpillar, Boeing Co (NYSE:BA) and Deere & Company (NYSE:DE) became easy targets in spite of their great fundamentals.
I’ve been long CAT stock for a while and profitable in that trade. This morning, management reported an excellent quarter where they beat expectations, and more importantly raised guidance going forward.
Management cited stronger demand than anticipated. This is as bullish a statement as can be for any company. Stronger demand on CAT products and services confirms my macroeconomic thesis for this year, so I want to add to my bullish exposure to CAT stock.
This time instead of adding shares or upside calls, I will use options to sell downside risk against proven support. This way I get to enjoy my longs in CAT without immediate incremental risk. My new levels of support allow for a sizable descent from current price just in case we hit more turbulent headlines that have nothing to do with deterioration of CAT business.
Fundamentally, CAT stock is not expensive from a price-earnings ratio. It is well priced within its competitors so there is no undue risk from a value perspective. Furthermore, the quality of the management team and the maturity of the company contribute to my strong conviction in the bullish thesis. Meaning this is a proven management team that is not likely to commit errors under normal operating conditions.
Wall Street experts are not overzealous on the stock which is good. And it is now trading well below their price target ranges leaving plenty of room of upside which fits with my bullish thesis on Caterpillar stock.
Technically, $160 per share has been difficult for CAT since the February correction. However it does now present an opportunity. The bulls have been setting higher lows and testing this neckline area. If it can break through that level then the upside target should be $168 per share or higher.
If I am long the stock I stay in it. And this additional risk described here would there by lower my entry cost with plenty of room for error.
Caterpillar Stock Trade Ideas
The Trade: Sell the CAT Nov $130 naked put and collect $3.30 to open. Here I have a 85% theoretical chance that I would retain maximum gains. But if the price falls below my strike then I accrue losses below $126.70.
Those who want to mitigate the risk that comes with selling naked puts can sell spreads instead.
The Alternate Trade: Sell the CAT Nov $130/$125 credit put spread. The spread has the same odds but would deliver 17% yield on risk. Neither trade require a rally to profit.
Since there are no guarantees when investing in stocks, I never risk more than I can afford to lose.
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.
