Deere & Company (NYSE:DE) reported earnings, and the knee-jerk reaction from Wall Street was to sell the stock down 2% on a headline, though it has since solidly reversed course. Management missed on the top and bottom line, so at face value it looked like a bad quarter for the equipment maker. However, now investors are delving into the details of the report.
Coming into this earnings report, Deere stock has lagged other equipment makers like Caterpillar Inc. (NYSE:CAT) year-to-date. But the whole sector has been under pressure from the tariff war headlines with China. They are easy targets for sanction retaliations should that happen.
Fundamentally, DE is cheap relative to the sector and in absolute terms. It sells at a 20 price-to-earnings ratio, so owning it at a discount from current price will not be a financial disaster. The globe is in a synchronized growth mode as money is still cheap and central banks are committed to low rates. So demand will stay strong for years to come and therein lies my opportunity.
Click to EnlargeI believe that we’ve seen the worst in DE stock and that the recent lows should hold through 2018. So instead of chasing upside hopium in DE, I will use options to sell downside risk into elevated fears. This way I don’t even need a rally to profit. I merely need the stock to hold above my support so I can retain my maximum potential gains.
Technically, DE stock is trading above $136 per share which has been the pivot for the last 12 months. Last November the bulls broke above it for a 30% rally which has since completely been retraced.
In the process, the bears unsuccessfully tested the neckline from which they broke out back in November.
Often enough, prior resistance levels become forward support. If that’s the case then Deere stock should have solid footing for future rallies. But I still prefer my setup where I bet on downside support rather than upside momentum materializing, especially in this elevated periods of volatility.
DE Stock Trade Ideas
The Trade: Sell the Sep DE $120 put and collect $2 per contract to open. This is a bullish trade with 85% theoretical odds of success. But if the price falls below $118 I will own shares and accrue losses.
Selling naked puts is a scary concept for a lot of traders. Those who want to mitigate the risk can sell a spread instead where it is more manageable.
The Alternate Trade: Sell the Sep DE $120/$115 bull put spread where I have the same chance of success but with much smaller dollars at risk. Yet, the spread will still deliver 13% in yield.
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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.
