Sometimes it is just too hard to understand why a stock acts like it does. Take Cummins (CMI) for instance. I wrote an article on the company about a month ago. At this point as I observed the company, I was convinced it was still headed down. With an announcement of a slowdown in China causing the company to lay off 1500 workers, one would think I was correct. The reaction to this news did cause the stock to gap down but it did not last long. Upon gapping, the stock found some footing and three days later immediately started to move up. It proceeded to rise from 86 clear to 102. All I needed to do was have the stock drop 1 more point to the 85 level and I would have been able to cash in on my original income play. This is the play I suggested:
The Options Trade
The stock is presently trading at $87.79. Since the outlook is not favorable for the stock, and it is presently trading in a bearish trend, I will look at a short-term income strategy trading with the trend.
- Buy the January 2013 put with a strike of "87.50" (priced at $6.00)
- Sell the January 2013 put with a strike of "85.00" (priced at $4.70)
- Net Debit to Start: $1.30
- Maximum Profit: $1.20
- Maximum Risk: net debit
- Maximum Length of Trade: four months
I still have plenty of time, but I am not convinced that the stock will fall back down to the 85 level by January anymore. Why the change of opinion? A lot happens in a month. Whether it is politicking or the truth we will not know immediately, but China's head of National Development and Reform Commission (NDRC), Zhang Ping, stated that China's economy has halted its slowing trend, adding that he was confident GDP growth would exceed 7.5 percent in 2012. This was one of the reasons the slowdown in the production level of Cummins was announced a little more than a month ago. At the same time, within the last three weeks, four different analysts have given Cummins a favorable rating. Look at these ratings:
- BMO Capital upgraded Cummins from Market Perform to Outperform with a price target of $120.00 (from $79.00).
- Analysts at Atlantic Securities reiterated an "overweight" rating on shares of Cummins in a research note to investors on Wednesday. They now have a $124.00 price target on the stock.
- The Jeffery Group reiterated a "buy" rating on shares of Cummins in a research note to investors on Thursday, November 1st.
- Analysts at Piper Jaffray upgraded shares of Cummins from a "neutral" rating to an "overweight" rating in a research note to investors on Thursday, October 18th.
So what do we do as investors with the stock? Should we turn bullish on a stock that was average during earnings this season? It met analysts' earning expectations but fell short on revenue like the majority of companies did this quarter and the second quarter. Engines (its largest sales unit) were down 2% overall while its truck engine parts in North America and other markets grew about 11%. This is understandable as companies are cutting costs and repairing instead of buying new.
Competitors like Caterpillar (CAT) and to a lesser degree Navistar International (NAV) have not risen as much as Cummins. In fact, NAV is still losing value while Caterpillar struggles with growth. For this reason, I am not yet convinced that CMI will just continue to move up yet. I believe in the next 6 months we could see the stock move up past the "102" level, but the markets are still dealing with "fiscal cliff" and European debt pressures.
The stock has been moving between some rather long peak and valley formations with smaller ones in between. I am not sure I would call the stock anything but neutral at this point with its movement. It looks like the stock is slowly but surely moving into a symmetrical triangular pattern that still has time before it looks like it would be ready to break out. The MACD indicator has mirrored the stock and gives us no hints of anything else. The RSI on the other hand is showing us a positive divergence taking place. Does this mean the stock is now going to move higher? Well it is not very strong so I wouldn't bet on it. It may not go down as far before it goes up again, but that is all. If it continues in this pattern, watch as Bollinger Bands contract now to come up to the stock price. 94.30 looks like a solid support level.
My opinion on where the stock is going
I am going to hold on to the options play that I originally created in October a while longer and not create a new one yet. Even though I am not convinced it will go clear down to "85," I am going to watch and wait it out to see how low the stock will go. I am not against analysts' opinion long term, but in the short term I am still expecting the stock to move down more before it moves up. As investors, if we can see good signals for a turn around in the economy and engine sales increasing, I believe we will then see the stock move up again and possibly push through the "102" level.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.