Bet Against Caterpillar

By Linda McDonough • December 29, 2016

Buy to open the February 17, 2017 put on Caterpillar Inc.(NYSE: CAT) with a strike price of $92.50 at $3.70 or lower. Symbol (CAT170217P92.5)

Caterpillar stock is up 11% since the presidential election based on hopes for big infrastructure spending. Although new dollars may be allocated to building projects, it is unlikely new Caterpillar equipment will be needed to get those projects done.

Caterpillar reports its December quarter on or about Jan. 26. The February expiration should capture the downside I expect from this release.

Demand for new equipment continues to weaken. For the nine months ending September equipment revenue declined 20.4%. Estimates for a lesser decline of 11% in the December quarter look optimistic based on management comments and recent used equipment auction results.

Management, who had supported flat earnings of $3.25 when it reported the September quarter on November 10, backed off on that projection at a brokerage conference on December 1. Management noted that this estimate was “too optimistic considering headwinds” in the industry. Such a change of heart in a short period of time illustrates a badly deteriorating market.
Ritchie Brothers Auctioneers, a publicly traded auctioneer of used industrial equipment, reported a less than expected auction sales number for the month of December. Although volume was up slightly, pricing was down 11%. Industrial customers and farmers who gorged on Caterpillar equipment the past few years due to low financing continue to flood the used market.

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Robert K

12/29/16 ‐ 3:53pm ET December 29, 2016 at 3:53pm ET

I’m in at $3.60. Thanks Linda!

Diamond Bob

12/29/16 ‐ 4:14pm ET December 29, 2016 at 4:14pm ET

Not CAT but CARB

Hi Linda, I wanted to share with you a trading strategy that I’ve used several times and get your thoughts about it. This trade was for Carbonite and done today.
STO March 20 PUT@3.55
BTO March 15 PUT@0.73
for credit of $2.82 making my break even $17.18. I did this 5 times and used the income to buy 80 shares of CARB.
Occasionally an opportunity comes along where the Put premium is unusually high and gives a good chance for a double win. I thought that was the case here.

I used the same strategy on Northstar Realty Finance and was able to sell a $13.00 PUT for $8.50 for a basis in the stock of $4.50. Rare but it happens. Company was going thru some problems. I now own 500 shares that are paying me $1.60 in yearly dividends.

I keep looking for flaws but so far this has worked well.

Your thoughts please and my best to you for the New Year.

Diamond Bob

Derek: Las Vegas, NV

12/29/16 ‐ 7:09pm ET December 29, 2016 at 7:09pm ET

It’s called a put credit spread. Those are the types of trades we do on a weekly basis over at Options for Income. It’s my favorite strategy!

Derek

Linda McDonough

12/30/16 ‐ 8:05am ET December 30, 2016 at 8:05am ET

That is a very interesting strategy Bob, I hadn’t noticed the divergence in those put prices, which does seem like it presents a good arbitrage. I’ll keep my eyes open in the future for trades like this. Thank you for the insight!
Linda

Pi Chi

12/29/16 ‐ 5:22pm ET December 29, 2016 at 5:22pm ET

Bought for $3.60 at Schwab. I wish everyone a Happy and Healthy New Year

Linda McDonough

12/30/16 ‐ 10:25am ET December 30, 2016 at 10:25am ET

Happy to have you on board. Thank you for the well wishes for the New Year, I wish the same to all of you.
Linda

Derek: Las Vegas, NV

12/29/16 ‐ 7:06pm ET December 29, 2016 at 7:06pm ET

You read my mind Linda, I placed this trade last week.

Derek

Linda McDonough

12/30/16 ‐ 8:04am ET December 30, 2016 at 8:04am ET

Nice thinking!

Linda McDonough

12/30/16 ‐ 10:24am ET December 30, 2016 at 10:24am ET

And by the way did you notice the WSJ today reported on CAT management’s recent change of heart regarding 2017 estimates?
Linda

Derek: Las Vegas, NV

12/31/16 ‐ 5:07am ET December 31, 2016 at 5:07am ET

I didn’t see the report. What is managements thinking for 2017 estimates now? I looked for the article, but I can’t find it.

Thanks Linda!

Derek

PS: Happy New Year

greenmaster

12/30/16 ‐ 2:36am ET December 30, 2016 at 2:36am ET

Hello to all. I just joined this service today. This CAT recommendation? I assume we are betting the stock will fall? if I do this trade, I will need $9300.00 cash in the account for every Put contract I buy?
Is there another strategy to use w/o having to put $9300.00 up. Like say, Buying straight out Calls or Puts? Please advise. Thanks.

Linda McDonough

12/30/16 ‐ 8:04am ET December 30, 2016 at 8:04am ET

Welcome aboard! You are correct- this is a bet that Caterpillar stock will drop below the $92.50 strike price. The suggested trade is to buy the puts. Each put contract mirrors 100 shares of stock so the capital for 10 of these puts for example is 10 puts x $3.70 (the price of the put) x 100= $3.700. You can also buy the puts in smaller lots. This is not an outright short sale which has unlimited risk- the capital at risk is the amount you have paid for the puts. Please let me know if this makes sense or if you have any other questions- I’m here to help!
Best,
Linda

greenmaster

12/30/16 ‐ 8:10am ET December 30, 2016 at 8:10am ET

Thanks for the response about CAT. I was thinking this was a Put Credit Spread or Sell 2 open Puts. I’m glad 2 see this is just a straight put opportunity. I just saw on CNBC this morning, that CAT was UP 37% this year. One of the best performers in the Dow. U really think it’s going to take a hit eh? We shall see. Just when do this happen do U know? Maybe wait a bit b4 entering a trade? Please advise. Thanks.

Derek: Las Vegas, NV

12/31/16 ‐ 5:36am ET December 31, 2016 at 5:36am ET

Hi greenmaster, I think Linda is right on this one. CAT is extremely overvalued (especially with the 37% increase in stock price), I think it will also take a hit because a lot of its business is overseas and with the strong dollar it will hurt earnings, even with Trumps stimulus plan.

Derek

greenmaster

12/30/16 ‐ 8:16am ET December 30, 2016 at 8:16am ET

What do u think about the FEB 90 Puts @$2.50? If the stock manages to jump up here shortly,which it might do today, then the 95 or 92.5p might work?

Linda McDonough

12/30/16 ‐ 10:23am ET December 30, 2016 at 10:23am ET

I think the 90 puts would work as well. CAT currently trades at a ridiculous PE of 30 on estimates of $3.20 for 2017. I think the $3.20 is too high. My long term target is in the $75 range but it’s always hard to know if the stock will pop on hope for fiscal spending. The January puts expire just one day after it reports fourth quarter earnings so I worry that series may not have time to reflect lower expectations.
Best,
Linda

greenmaster

12/31/16 ‐ 6:29am ET December 31, 2016 at 6:29am ET

I bought the FEB 90 Puts @ $2.80. U say U have a target of $76.00/share? I’m looking at some lower strikes out of the money. Long Term Puts. If it falls just $10/share, the puts would work out just fine. I would think however, for the stock to fall to $80 or lower, don’t U think the whole market would have to pull back? If the Dow continues to climb back to new highs, that could carry CAT higher. We shall see what happens? K. Thanks.

Linda McDonough

01/02/17 ‐ 4:30pm ET January 2, 2017 at 4:30pm ET

My target is a longer term target. Although the options might still work, it becomes tricky to get the timing right for strikes that are significantly lower or higher than current prices. Of course those options are usually much lower priced so although risky they can deliver great returns!
Linda

greenmaster

12/31/16 ‐ 6:33am ET December 31, 2016 at 6:33am ET

Hello Linda. You are advising to but these CAT Puts. If the earnings report is due out in 3 weeks, why are we buying puts so early? What is the reasoning? Just wondering? Please advise. Thanks.

Linda McDonough

01/02/17 ‐ 4:27pm ET January 2, 2017 at 4:27pm ET

The timing on options is tricky. Although the calls typically become cheaper the closer you buy them to the expiration date, I think the stock will weaken in advance as investors become nervous about earnings. I have found it better to give myself a bit more time for my bullish or bearish scenario to play out. That doesn’t mean it will always be the very best trade, there are many ways to skin a cat with options.
Best,
Linda

greenmaster

01/03/17 ‐ 6:56am ET January 3, 2017 at 6:56am ET

Welcome to my nightmare. I knew it. CAT is going 2 be up today. But it most likely won’t hold these levels. So stay on course to the downside and I may buy more Puts. I sure hope ur right about this stock. We shall see where things go? Happy New Year!

Diamond Bob

12/30/16 ‐ 9:24am ET December 30, 2016 at 9:24am ET

Derek, Thanks for your response. I also love PUT credit spreads and do them all the time. Would selling a PUT and buying the stock be called a “sell/write”? I’ve done this on 8 different stocks and have had 5 winners and 3 still working. I usually use leaps to take in the most premium. I like it for high yield dividend stocks that I expect to keep for the long run. On several of them I’ve sold multiple PUTS over time to further reduce my basis.

Linda, thanks for your comment as well. I appreciate that.
DB

Derek: Las Vegas, NV

12/31/16 ‐ 5:30am ET December 31, 2016 at 5:30am ET

Hi Bob, I think you’re referring to a buy/write, however most investors sell a call on the stock they own (covered call or buy/write). Selling a covered call protects your downside risk and selling a covered put does not. If your covered put is ITM you could end up with an extra 100 shares of the stock if it gets assigned to you. If the covered call is ITM your 100 shares could get called away from you, but you will receive max profit, unlike a covered put. If you want to limit your capital at risk you could always use the covered call strategy on your LEAP. For example, buy a ITM LEAP and sell a shorter term OTM call a few strike prices above the stock price; once the shorter term option expires you can repeat the process for additional credits. It’s much cheaper than a straight covered call and your risk is reduced as well (no need to own the stock). Another thing to think about, if you’re using LEAP’s to cover your stock you could probably make more money selling multiple shorter term calls/puts.

There’s so many strategies you can use and it seems like you’re doing well, so I guess with the information I gave you, you could weigh your options. I hope this helps!

Derek

PS: Happy New Year!

Linda McDonough

01/02/17 ‐ 4:31pm ET January 2, 2017 at 4:31pm ET

Thanks for all these interesting strategies Derek!
Happy New Year.
Linda

Melody Pfingsten

01/04/17 ‐ 3:20pm ET January 4, 2017 at 3:20pm ET

Linda, I hope you are right. I however, tried a put with CAT this past year and lost all the money. The biggest reason is people love the dividend. It did not matter that CAT management came out and said that things were not good. Trump getting elected increased the stock by 10%. I personally do not see CAT being that big of a deal with his infrastructure plan.
1. Bay bridge in SF bay area cost 350B to build; obviously not done well but still 1 T dollars is maybe 10 bridges. US simply does not have 100T to do massive infrastructure work.
Good luck with this trade but I have been burned and will not short stocks that have big dividends.

Rick

01/04/17 ‐ 3:30pm ET January 4, 2017 at 3:30pm ET

Linda, Thanks for sharing your experience. It will be interesting to see if our PUT does not work, and if so, I will file your thesis for future use.

Linda McDonough

01/04/17 ‐ 8:27pm ET January 4, 2017 at 8:27pm ET

Rick,
You’re welcome. I think the CAT story may play out a few times this year. It typically takes quite a bit of time for a major shift in demand to play through the numbers. CAT is probably later in the cycle but the stock seems to be trading on pure optimism for possible funding.
Linda

Linda McDonough

01/04/17 ‐ 8:25pm ET January 4, 2017 at 8:25pm ET

Melody,
I agree that CAT has been a difficult short and that in the long run investors do not like to sell big yield stocks. CAT’s current yield is 3.3%, good, but not as attractive as it once was. This is a shorter term bet that earnings estimates will be lowered once again. Although some equipment will be purchased if huge federal funding comes through, the used market is glutted and prices are soft. This eventually hits the company’s finance division as well. I was happy to see the stock down a bit on such a strong day.
Best,
Linda

greenmaster

01/25/17 ‐ 7:30am ET January 25, 2017 at 7:30am ET

Hello Linda. As we have witnessed here in the last 3 weeks, CAT just continues to head higher. These Puts are looking to be very high risk. Stock is now around $97.00. I’m trying to prepare myself for a major disappointment and a loss of funds on this one. I just can’t see this stock falling any where near to $90.00. What are ur thoughts these days? Please advise. Thanks.

Linda McDonough

01/25/17 ‐ 9:38am ET January 25, 2017 at 9:38am ET

CAT has indeed marched higher with the rest of the market, particularly the industrial group. My bet is that its guidance for this fiscal year will not match Street expectations when it reports earnings tomorrow. Just this morning the company announced sales data for the month of December. While the decline improved slightly from the prior two months (down 12% vs. average down 14.5%), it looks very difficult for the company to have sales flat in 2017 with 2016.

Options are inherently very risky tools to play the market. They are priced dynamically to assess the risk of a stock hitting a certain price target by a certain date. Every time you buy an option you are basically betting against the market. I typically opt for further out expiration dates as it is impossible to predict the short term move of stock perfectly (wouldn’t we all love if we could?).

While it is unpalatable to have an option drop so much, your loss is limited to the amount you have invested in this bearish position versus an unlimited loss if you were outright short the stock. Obviously I wish the market weren’t looking so favorably on this group but I do not think it reflects the poor fundamental operations of CAT’s business. CAT reports tomorrow before the open. I’ll be posting my thoughts.

Best,
Linda

black arrow

01/25/17 ‐ 11:51am ET January 25, 2017 at 11:51am ET

Thanks for the update on Cat tomorrow AM. I will be watching it.
I didn’t swing for the fences here, so will be able to use the french phrase,
C’est La Vie

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