Caterpillar’s (CAT) stellar earnings report released last night sets up the opportunity for a vertical spread, or a bear call spread.
THE BACKGROUND
The company reported a fourth-quarter profit of $1.55 billion. Earnings per share (EPS) were $2.32. These numbers readily beat estimates, and the stock gapped up during the overnight session.
This gap was preceded by a very strong run-up, with the stock running from 92.36 at the beginning of the year to current prices. Prices also are retesting levels not seen since the summer of 2011.
The good news may be priced in -- for now, and the stock could use some consolidation as profit takers step up into resistance.
TRADE IDEA
A simple way to trade that thesis is to sell a vertical spread, known as a bear call spread. Specifically, a trader could sell the March 120/125 bear call spread for 0.75 or higher.
The trader would collect a credit of $75 and assume a maximum risk of $425. If CAT stays under 120 until March options expiration, the trade will expire at a full credit.
The risk of full loss should never be realized, so a price stop of a close above 120 would be prudent, and that would put investors risk at -$127 per spread, and that loss will decrease over time due to the time decay in the options.
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