I don't know a lot about Caterpillar (NYSE:CAT), but I do know a lot about trading options, and the implied volatility of the CAT weekly options is about 5% higher than it is for the October options that expire in four weeks. This means there might be some good money to be made by buying the October options and selling weeklies against them.
My favorite options strategy is to find underlying stocks that don't have any huge expected news coming out (which might cause unusual volatility when it breaks), and that have an implied volatility advantage such as CAT has right now. I then buy calendar spreads at several strikes both above and below the stock price.
Calendar spreads do best when the stock stays absolutely flat. These spreads hate volatility. When the short weeklies expire, the calendar spread that is at the strike closest to the stock price on that day creates the greatest gain for the investor. So buying spreads at several strikes gives you more chances to score big on one of them.
I take the position that I have no idea which way the stock might move in a single week, so I try to protect myself from a move in either direction by buying calendar spreads both at strikes above and below the stock price.
For some stocks, like Apple (NASDAQ:AAPL) (on which I am quite bullish), I would buy more calendar spreads at strikes above the stock price than below it. See my Seeking Alpha article How We Made 613% With Apple Options In 7 Weeks And Expect To Do It Again In 4 Months
Here is the risk profile graph for a portfolio of CAT calendar spreads that I placed on Monday, September 24. They cost a total of about $4,200, including commissions. It shows the expected gain or loss at each of the possible stock prices when the weekly options expire on September 29.
(click image to enlarge)
I purchased 10 calendar spreads at each of the 87.5, 90, 92.5, and 95 strikes, buying Oct-12 options and selling the weeklies that expire on Friday, September 28, 2012. All of the spreads are in calls except the 87.5 strike, which is in puts. The price for each of the spreads is indicated in the third from last column in the green part of the table.
(I prefer to use calls for strikes above the stock price and puts for strikes below the stock price because better executions are generally available when you are rolling over short options to the next weeklies. Out-of-the-money options typically have smaller bid-ask spreads than in-the-money options, so better prices are often possible to get. The 90 spreads are below the stock price, but for some reason, the put spreads are quite a bit more expensive than the call spreads right now, so I opted for calls on the 90 spreads.)
As I mentioned, these spreads would cost about $4,200 (including commissions) to place on Monday, when the stock was trading at $91.45. The risk profile graph shows that if the stock fluctuates less than $1.50 in either direction this week, I expect to make about 25% on my investment in a single week.
If the stock fluctuates $3 either up or down, a profit still results -- about 10% if the move is on the upside, and about 15% if it on the downside. These seem like pretty good odds to me.
On Friday, I would typically buy back the expiring options and sell the same-strike next series of weeklies (expiring October 5, 2012). The trade would be selling a calendar spread. Each spread would be done for a credit, and the cash might be salted away. Or more typically, I would buy new calendar spreads, which would create a similar graph for the next week, with the sweet spot in the middle, so that the stock could move about the same amount in either direction before a loss situation is encountered.
I believe that such a strategy of using calendar spreads is one of the most profitable investment ideas available today. It takes a little work (and understanding of options) but it surely seems worth the effort to me (a good way to learn about options is available at TerrysTips.com). Right now, the implied volatility of the CAT options looks like a potential big winner to me.
Disclosure: I am long AAPL, CAT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.