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Ilene is an editor at Phil's Stock World, Market Shadows and other financial publications. Her educational background is in biology, pathology and law. After working in biochemistry and pathology during her graduate years, she attended Law School at Loyola. She practiced law in a number of... More
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  • Become A Cat Lover 0 comments
    Feb 25, 2013 12:33 AM | about stocks: CAT

    Paul Price is SELLING one CAT Jan. 2014 $100 Put in the Market Shadows Virtual Put Selling Portfolio.

    Featured in: MarketShadows February 24 2013 Newsletter: Not Done Rising, But Night Will Come

    Become a Cat Lover

    By Paul Price

    The world's largest producer of earthmoving equipment has dropped dramatically since early 2012 as fears of a global economic slowdown have taken hold. Caterpillar (CAT, $91.45) topped out at $116.95 less than a year ago and was $99.70 as recently as February 1, 2013. The stock was trading for $91.45 at 3:15 pm EST on Friday.

    (click to enlarge)

    The three best buying opportunities of the past 26 months all came at P/E multiples and yields very similar to those now. Prior selloffs were associated with similar a negative psychological environment as present today.

    The riskiest times came from buying Caterpillar when all the news was positive. At those junctures, CAT sported higher P/Es and lower yields than now (see chart). Apple (NASDAQ:AAPL) was a similar story last fall. Traders were fearless going into AAPL above $700 last September, yet hesitate to plunge in today at around $445.

    CAT is rated A+ for financial strength and has outperformed 90% of Value Line's 1700 stock research universe over the long haul. Investors have been well-rewarded for taking on CAT's high beta (@ 1.35) and its inherent lack of near-term predictability in earnings.

    With CAT trading for $91.45, it offers a very sustainable 2.27% yield at only a 22.2% payout ratio based on the already reported, trailing 12-month earnings of $9.36. Dividend grew 197% since 2002. The annual rate climbed from $0.70 to $2.08.

    Even though CAT's earnings may dip in 2013, the 13% drop in profits expected by Zacks would still put CAT at just 11.1x its already reduced forward estimate. That is far from a scary valuation.

    Morningstar sees fair value as $106 or about 16% above Friday afternoon's price of $91.45. Standard & Poors takes a slightly more positive view with its 12-month target price of $117.

    (click to enlarge)

    Caterpillar offers solid upside through outright purchase. Selling one January 2014 $100 Put is a conservative way to play CAT's upside.

    Here's what the math looks like for writers (sellers) of a January 2014 $100 Put contract at current quotes.

    (click to enlarge)

    If we sell one Jan. 2014 $100 Put for $14.60 now, and CAT is trading below $100 at expiration, then 100 shares of CAT will be "put" to us at expiration - i.e., we will buy 100 shares for $100 on Jan. 18, 2014.

    Our net cost (break-even) will be $85.40/share because we keep the $14.60 premium for selling the Put. The $14.60 offsets the $100 share price we pay if CAT is trading below $100. Thus, as long as CAT is above $85.40 at expiration, we have broken even (CAT at $85.40) or achieved a profit (CAT above $85.40).

    If CAT rises to $100 or above by Jan. 18, 2014:

    • Jan. 2014 $100 strike-price put expires worthless
    • We keep $1,460 as pure profit (the put contract is $14.60 per 100 shares - a contract is for 100 shares)
    • Our obligation to buy CAT below $100 disappears

    This best-case scenario will occur on any move up of $8.55 or greater (+ 9.35% from the trade inception price of $91.45).

    If CAT remains below $100 on Jan. 18, 2014:

    • Jan. 2014 $100 put is exercised by the buyer
    • We will be forced to buy 100 shares of CAT per put contract sold for $100/share
    • We will need to lay out $10,000 in cash per put contract
    • Our final position will be 100 CAT at a net cost of $8,540 - i.e. we owe $10,000 for 100 shares, but that is offset by the $1,460 we collected for selling the put.

    The worst-case scenario purchase price of $85.40 per share is 6.6% below the trade inception price. It's closer to the 52-week low of $78.25 than to CAT's yearly peak of $116.95. The effective yield would be 2.44% based on the current payout level. Our P/E would be reduced to just 9.12x the actual 2012 reported EPS.

    We are going to SELL one CAT Jan. 18, 2014 put @ $14.60 /share to our Virtual Put selling portfolio today, Feb. 22, 2013.

    Disclosure: Long CAT shares at the time of publication.

    Stocks: CAT
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