February 16th, 2023

Is CAT Ready To Pounce?

Before I get into my take on Caterpillar (CAT), let’s take a look at what’s going on in the market.

Retail numbers shocked the market yesterday, jumping 3% month-over-month vs the 1.7% expected. Industrial Production numbers came in under expectations, while Manufacturing Output exceeded expectations. That brought out another rollercoaster trading day, but I’m looking at something else. This is the second day in a row that was trading lower in the morning and rallied in the afternoon session.

Here’s a chart of the S&P 500 (SPX) showing the market opened lower, but ultimately finished higher at the end of the day.

You may be wondering if stronger retail sales are good for the economy and the market, but remember we also just had a report that came out that said inflation month-over-month ticked up by 0.5%, so part of the increase in retail sales is coming from a higher cost of the same goods.

This is setting up to have another interesting day after a slew of economic reports today, including Housing, Jobless Claims, Philadelphia Manufacturing, and PPI-Final Demand.

We’re still in the uptrend that started in mid-December and the market has been able to shake off any negative news. Until the trend line is broken, there’s no reason to think we can’t go higher from here. However, we had 4 “green” days in a row and we haven’t been able to clear the most recent swing high. That could mean this trend is getting exhausted. Or this is a consolidation period and we’re about to start the next leg higher.

If the last two days are any indication, I’m expecting a rocky morning session, with the potential of climbing higher in the afternoon.

The trade of the day involves Caterpillar (CAT). The stock has a tendency to consolidate, move higher, consolidate, move higher, and so on. Is CAT ready to head higher from here?

CAT closed higher yesterday by nearly 2%, and I’d normally sell a bull put spread on a day when the stock is trading lower. Selling puts on a down day is a way to enhance the credit you receive when you’re selling a put.

In our case, the stock is a little too pricey for me to sell a cash-secured put, so I’m looking to create a credit spread – meaning, sell a put option just out of the money, and buy a put at the same expiration date further out of the money.
Normally, I want to see at least $1.25 in credit for a $5-wide spread, but for the purpose of this example, I’ll make an exception. This spread could easily trade for higher than $1.25 if you wait for CAT to have a down day.

I’m looking to sell the 24-MAR 240 put while simultaneously buying the 24-MAR 235 put. This is going for $1.12 in after-hours trading.

SELL -1 VERTICAL CAT 100 (Weeklys) 24 MAR 23 240/235 PUT @1.12 LMT MARK

Here is the risk graph of the spread. I’m looking for a profit target of at least 50% of the credit received. My mental stop loss is selling the spread if the underlying crosses below the sold strike. That is 3.5% away from the current price, so we have some room for the stock to go down slightly before I bail on the trade.

If CAT trades down 3.5% today, the most I’d lose is about $75. Every day that goes by means the loss would be less since the option decays with time.

Here are the levels on the stock graph. The sold strike works as a stop loss here because that also corresponds to just under the line of support. A break below here would be a break of the support line and we’d want out anyway.

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Jeff Wood

Editor, Filthy Rich Dirt Poor
Coach, Options Testing Lab

Any trade or trade idea discussed is for educational purposes only.  They will not be tracked as an official trade recommendation.