Only individuals who are bullish on Caterpillar (CAT) should consider employing this strategy. If you are not bullish on this stock, then it would be in your interest to look for alternative plays.
Reasons to be bullish on Caterpillar:
- A five dividend growth rate of almost 6%
- Percentage held by institutions is 65%
- A strong quarterly revenue growth rate of 23%
- A great free cash flow yield of 11.25%
- A levered free cash flow of $471 million
- A low payout ratio of 23%
- A great Retention rate of 77%
- A good quarterly earnings growth rate of 29%
- A good interest coverage ratio of 8
- Cash flow per share doubled from $5.94 in 2009 to $11.95 in 2011.
- Annual EPS before NRI increased from $5.37 in 2007 to $7.81 in 2011
- Year over year projected growth rate of 24.6% and 18.3% in 2012 and 2013 respectively
- A 3-5 year projected EPS growth rate of 23%
- The merger with Bucyrus will position the new company as the leading global mining equipment manufacturer. Management expects the acquisition to be accretive and contribute over $450 million to its bottom line. This acquisition will help Caterpillar gain a strong foothold in strong mining markets such as China and India. It will also be in a good position to leverage Bucyrus in the thriving after market parts business while providing supporting services for its own equipment.
- Its backlog has continued to increase, and it now stands at a record level of $30.7 billion, up from 29.8 billion at the end of 2011.
Suggested strategy for Caterpillar Inc
Part I
The Jan 2013 80 puts are trading in the 7.65-7.57 ranges. For this example, we will assume the puts are sold at 7.65 or better. For each contract sold $765 will be deposited into your account. If you do not want to leverage your position in this stock, you could stop here and walk away with a gain of 9.5% or have the shares assigned to your account at a much lower price. If the shares are assigned to your account, your final cost would be 73.35.
Part II
The Jan 2013 105 calls are trading in the 2.59-2.67 ranges. For this example, we will assume that the calls can be purchased for 2.67. For each put sold you will be able to purchase two calls and still have $231 in extra cash to spare per put sold.
Risk factor
If the shares trade below the strike price, the puts were sold at, the shares could be assigned to your account. Your final price would depend on the number of calls you purchased and could range from $75.20-$77.69. As you were bullish on the stock to begin with, this should not be a problem. Furthermore, you still have the leverage in place, so if the stock does take off you will benefit from both ends. One from purchasing the shares at a lower price and second from the calls you hold.
Advantages of the strategy
You get to leverage your position for free and there is also the possibility that you could get into this stock at a lower price. If the stock takes off the calls, you hold could significantly rise in value.
Conclusion
In general, a great way to get into a stock that you are bullish on is to sell puts at strikes you would not mind owning the stock at. Investors looking for other ideas might find this article to be of interest - Turbo-Charge Your Position In American Capital Agency.
Disclaimer
This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: EPS and Price vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Options tables sourced from money.msn.com. Ycharts data sourced from ycharts.com.
