Caterpillar (NYSE:CAT) reported earnings this morning and investors liked what they saw. Management beat on both the top- and bottom-line expectations. More importantly, they raised the full-year outlook.
This is a nice change from the last earnings reaction where the CFO comments were misconstrued. So those fateful comments of “high watermark” were indeed fake news.
CAT stock came into the earnings report up 24% in one year, so the setup for a dip was real. But given the last dip on its last report investors were full of angst about a potential repeat.
Fundamentally CAT is set up to do well in this macro environment. We are still in a growth global cycle so there should still be plenty of business upside for a leading equipment provider like this.
Management is still successfully executing on plans and they rarely give Wall Street a fundamental reason to sell the stock. Three months ago, the CFO’s words were twisted into a fear mongering selloff that took the whole sector down. And therein lied the opportunity.
Today’s trade benefits from the stabilization cycle in CAT stock.
Since February, industrial stocks like Caterpillar, Deere (NYSE:DE) and Boeing (NYSE:BA) have been unstable due to the headlines around tariff wars with China. The businesses of these companies lie directly in the line of fire. They are easy targets for China’s retaliations. In reality there are few alternatives for their products so for now, the fears have been overblown and dips have been opportunities for scalp trades.
Technically, there is upside potential in Caterpillar stock. If the bulls can stay above $145 then they would have the opportunity to fill the gaps all the way up to $155 and above.
Fundamentally, CAT stock is not expensive. It sells at an 18 trailing price-to-earnings ratio. So owning the shares at a discount from here is not likely to be a financial mistake.
This is important to my trade today because that would be the worst case scenario … that I own shares of CAT at my strike. I am confident that if that happens, I will manage out of my shares for a profit in the long run.
I could add a Sep debit call spread at $145-per-share to capture the upside but in order to keep my portfolio in balance, I want to simply bet on the downside support instead.
I have more faith in the proven support levels than betting on the upside hopium. This allows me to have better conviction to withstand dips from tariff headlines.
The experts on Wall Street agree with me since CAT stock is trading well below their average price range. Also, now that the uncertainty of earnings is out of the way, we may have a few upgrade headlines to fuel the next leg higher.
The Trade: Sell the CAT Jan 2019 $120 naked put and collect $2.70 to open. Here I have an 85% theoretical chance that I would retain maximum gains. But if the price falls below my strike, then I accrue losses below $117.30.
Those who want to mitigate the risk that comes with selling naked puts can sell spreads instead.
The Alternate Trade: Sell the CAT Jan 2019 $120/$115 credit put spread. The spread has the same odds, but would deliver 15% yield on risk. Neither trade requires a rally to profit.
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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.
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