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Dissecting Event-Based Options Trading in Caterpillar (NYSE: CAT)

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Earlier this month, Robert Baird upgraded Caterpillar (NYSE: CAT) to “outperform” (buy) from “neutral” (hold) and said the shares could advance as high as $88 over a 12-month period.  Baird upgraded a number of diversified industrial names that day, citing increased hopes for continued macroeconomic recovery.  CAT shares have gained roughly 33% since the first week of February and are currently trading at $67.72.

There is a strong bullish sentiment surrounding CAT, as 11 of the 23 analysts covering the shares name it a “strong buy” in addition to one “moderate buy.” The company is expected to release its earnings report Monday morning ahead of the open.  Analysts expect per-share results of 39 cents, equal to last year’s earnings for the same time period.  CAT has topped analysts’ expectations in each of the past four consecutive quarters by a healthy average margin of (coincidentally) 39 cents.

Investors who want to include CAT in their portfolio but do not wish to devote the nearly $7,000 required to buy 100 shares could consider option-trading alternatives (as could contrarian investors who want to take a more neutral stance).  Here are two hypothetical trades that are not recommendations, just examples how two different strategies might play out.

*Prices given as of Wednesday afternoon

Bullish Option Strategy: Bull Call Spread

Investors who expect CAT shares to continue higher could buy the August 60/70 bull call spread (buying the 60 call, selling the 70 call) for a net debit of $6.00.  If CAT moves lower than $60, investors can lose their entire premium paid, but can profit as much as $4.00 (return on risk of more than 66%) if CAT moves above $70.00.  Breakeven for this strategy is $66.00 at expiration, so even if CAT is unchanged by August expiry, the trade will show a profit.

Neutral Option Strategy: Iron Condor

Investors who think CAT is ready to enter a sideways trading range could capitalize on this neutral outlook with an iron condor.  Simultaneously short the June 60/55 bull put spread (selling the 60 put, buying the 55) and the June 75/80 bear call spread (selling the 75 strike, buying the 80 strike) and collect an overall credit of 93 cents.  If CAT is trading anywhere between 60 and 75 when these calls expire, the spread trader keeps this credit as profit.  Below the downside breakeven ($59.07) or above the upside breakeven ($75.93), the condor begins to lose money.  The maximum potential loss, capped at $4.07, is achieved at 55 and below and 80 and above.

What’s Your Take?

Will the Caterpillar (CAT) rally continue or run into resistance?  And what do you expect from the company’s earnings report on Monday?

Compare OptionsHouse rates for stock options with other brokers. For investors who are new to options and want to try out their trades without committing real money, practice using a free virtual trading account.

Photo Credit: Dominc Alves

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The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

 

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