Trade Idea: Digging In For An Easy Options Trade

| About: Caterpillar Inc. (CAT)
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Caterpillar (NYSE:CAT) is a well known company with a reliable history of dividend payments. It went ex-dividend on July 18, 2012 and has a payout of .52 on August 20, 2012. The annual yield is 2.34%, which is low - but better lower and stable than higher and bankrupt.

I like the company and I like the dividend, but that is not my current interest in this stock. I favor this stock because it is a great candidate for an easy options strategy - a bull put spread.

Let's take a look at the chart:

On this weekly chart, we can wee that CAT recently came down and tested its 200-weekly EMA. The stochastics have turned up from oversold 20 and the MACD histogram is stairstepping up. This is one of my favorite trade set-ups. Remember this is the weekly chart so the longer-term time frame is bullish. We effectively made a higher low.

On this daily chart, we see a bottom put into place and the subsequent breakout with only two levels of resistance to overcome.

Because the overall market is hesitating at a probable top SPY 1407, we want to choose options strikes that should not really be affected by the correction, which I anticipate being 30-50 points overall.

In looking at the weekly chart, I feel that putting on a spread trade under the 200-weekly EMA is a prudent risk/reward. I ask myself: Is there a chance in heck this can be easily hit? If the answer is no, it is a viable candidate. I would rather take a lower premium for lower risk.

The spread that best fits my risk profile is the November 77.5/72.5 bull put spread for a net credit of $.72. It is a $5 spread, so my risk is the spread ($5), less the credit collected $.72) = $428 risk per contract. This risk can be lowered by the use of stops - I would consider exiting the trade at the point I had to buy back the spread for $1.50 or so. Remember that a bull put spread is a BULLISH stance on the stock.

The cool thing about doing credit spreads is that you don't have to pick an overall direction or price target, you are simply saying "I don't think the price will be $X here by the third Friday in November."

To execute this trade: Sell to open the November 77.5 puts, and buy to open the November 72.5 puts, collecting the credit of $.72 ($72.00) per contract. You must have spread approval within your account in order to execute this trade. More aggressive traders may consider taking the 80/75 spread for a net credit of .92. I prefer the lower strike as the more aggressive strike is right at the 200 weekly EMA and I prefer to be under a significant moving average. That is a personal choice for you, only you know your comfortable risk/reward.

The hardest thing for many options traders is not to tinker with the spread once it has been executed. If you keep your fingers to yourself, the ultimate outcome is that CAT stays above your highest strike and your spread expires worthless, which gives you max profit. Another thing to keep in mind is that you will see the material increase in profit closer to expiry as the time value leaks out. As always, maintain proper risk controls with the proper use of position sizes.

If you are new to credit spreads, call your broker and have him or her walk you through the entry. It is what the broker gets paid for. Some platforms are not spread friendly - you may have to enter each leg separately. If that happens, simply calculate what you need to buy each leg separately for to collect the premium. If you enter using two separate entries, be aware you may have to exit using two separate entries.

I use this trade as a staple in my portfolio; it has been a reliable trade that has always (for me) expired worthless. It is one of those trades that you can put on and sleep well at night.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CAT over the next 72 hours.

Disclaimer: MSCM and/or I may or may not have a position in this stock which may or may not be exited without advance notice. Data is provided for informational and educational purposes only and is not offered as investment advice. Timing of transactions can be critical to the success of a position. MSCM, its employees or owners shall not be liable for any errors or delay in the content, or for any action taken in reliance on any content provided within. Opinions expressed here are the sole opinions of the author and not representative of any firm view.