Caterpillar (NYSE:CAT) has had an epic 26% return thus far this year. However, recently, the Dow blue-chipper has run into some resistance trading in the 114s. Caterpillar has traded up to the 114 area 8 out of the 12 trading days in February, only to fail to close above that mark all but one time. The following article will show a cheap option play proven to capitalize on this resistance.
Below is a chart of Caterpillar's trading for the month of February 2012. The open, high, low, and close is included for each day. In parentheticals, are the trading ranges for the March 105 CAT puts. As you can see, Caterpillar has traded in the 114s 8 times this month, but has registered only one close above it - on Valentine's day. 114 has proven to be a strong resistance point for this stock and a perfect swing trade opportunity for option players.
If you purchased a March 105 put whenever the stock traded in the 114 area, you could have sold it for a profit every time the following day as the chart illustrates. In fact, the average return from the high on the day it traded in the 114s to the low the very next day was a staggering 41%. Today, February 16, it again traded in the 114s, but failed to close above it. The March 105 put was .98c (cost to buy one = $98). IF the trend continues, CAT should trade lower at some point on Friday, allowing for the put to be sold at a higher price. Notably, this option play is not considered day trading since the option was purchased and sold on two different trading days. This is a proven, cheap short term option play for those who want to take advantage of the recent choppiness in the market. The 105 strike was chosen for analysis only because the cost basis is low. For those willing to pay more, and gain a bit more safety, the 110 strike is a viable option as well. The delta and theta is much more suitable at that strike, especially for those who want to hold on to the option longer.
The conditions in the market indicate a short, but healthy, correction may soon occur. Many commentators have pointed out that as the Dow nears 13000 (and the SPDR (NYSEARCA:SPY) in the 136-137 levels), a 3% or more correction may be in the cards for a number of reasons including, but not limited to, overwhelmingly high bullish sentiment (contrarian signal), geopolitical concerns, institutional outflows of money, and the ongoing European saga. The Dow, S&P, and Nasdaq are currently sitting at multi-year highs. Thus, buying a put is a potentially profitable strategy to capitalize on a downturn in the interim.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.