The Recent Rally in Caterpillar Stock Has Reached an Extreme

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CAT Stock - The Recent Rally in Caterpillar Stock Has Reached an Extreme

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Shares of Caterpillar ( NYSE:CAT ) have been on fire lately. CAT stock has risen nearly 10% over the past seven days as Chinese tariff fears eased. Certainly some of the move higher was justified given the lessening of the trade war bluster. Caterpillar shares, however, have come too far, too fast. Look for the red-hot rally to cool in the coming weeks.

Caterpillar stock is no longer cheap on a fundamental basis. The price to earnings (P/E) ratio is now over 30 while price to sales (P/S) is at 1.8, a big premium to the five-year average of just 1.2. Price to cash flow is at an extreme as well at 19.4. The dividend yield of 2.2% is well below the 2.9% average over the past five years. These comparatively rich valuations will be a strong headwind to any further move higher in CAT stock.


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CAT stock is getting extremely overbought from a technical perspective. The 9-day RSI is nearing the highest readings of the past year at 86. The last time Caterpillar saw such euphoria proved to be a significant top in the stock.

MACD is also at extreme levels that marked short-term peaks. Bollinger band percentage just exceeded 100 for the first time in 12 months, yet another reliable indication that the rally may be approaching a climax.

Shares are approaching major overhead resistance at the $160 area. CAT stock has attempted on five separate occasions to break past this level, only to fail each time. This should likely prove to be a major hurdle for Caterpillar to overcome.

I am not looking for any major pullback in CAT, but instead just a period of consolidation following such a strong rally. An out of the money call credit spread fits this viewpoint ideally. CAT is due to report earnings near the end of October, so important to make sure the options expire before then to avoid any earings related risk.

CAT Stock Trade Idea

Buy CAT Oct $170 calls and sell CAT Oct $165 calls for a 60-cent net credit.

Maximum gain on the trade is $60 per spread with maximum risk of $440 per spread. Return on risk is 13.6%. The short $165 strike price provides a 5.8% upside cushion to the $156 closing price of CAT stock and is above the major resistance level of $160.

Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility.

Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, four years as Lead Options Strategist at ThinkorSwim and three years as a Market Maker for First Options in Chicago. Tim makes weekly appearances on Bloomberg TV  “Options Insight”, Business First AM “Trader Talk”, TD Ameritade Network “Morning Trade Live” and CBOE-TV “Vol 411” to discuss everything from volatility and option related.


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