By Donald E. L. Johnson
Valuentum.com's Callum Turcan writes on SeekingAlpha.com that Caterpillar is a financially strong company with the kind of free cash flow and balance sheet that gives its adjusted dividend cushion a relatively high ranking of 2.5. That means its dividend not only safe, but also given a decent world economy it is poised to grow that dividend. But the world economy isn't looking so great.
I posted a first draft of this blog in the comment's section below Turcan's excellent piece, not just because I'm a long time owner, but also because it's a good stock for generating income by writing covered calls and selling puts. The options are liquid and deep, which gives me a lot of ways to play CAT's options. Liquid options have good volumes and open interest. Deep stocks are liquid over several stock price strikes. I'll outline my recent and current CAT options trades below.
Caterpillar is a wide moat company with numerous competitive advantages for the whole company and for many of its products and markets. While wide moat companies' stocks usually don't out perform no moat companies, according to a study by Morningstar.com that is cited by Brian Nelson in Value Trap, CAT's performance over some 90 plus years has outpaced a lot of companies.
CAT's competitive advantages are its brands, continuous improvement and innovation, strong dealer and service networks, outstanding parts business and its ability to finance its customers.
The reason investors like wide and narrow moat stocks is that they're less volatile than no moat stocks. Moat stocks may not make as much money for investors as no moats, but they let their owners sleep better at night. And most moat stocks pay reasonable dividends that serve as double taxed savings accounts for investors. Morningstar.com lists 191 wide moat stocks and 492 narrow moat stocks under the "research" tab on a major broker's web site.
CAT is a material handling giant and conglomerate. It's diversified across many materials handling product lines, target markets and both developed and emerging markets. It's been internationally diversified since the late 1940s and seems to survive regardless of the politics of the host countries.
So far, CAT's CEOs are mostly promoted from within. CAT is not GE, which, interestingly, also is on Morningstar's list of wide moat stocks.
Valuentum doesn't talk about CAT's wide moat because what drives enterprise values are a growing free cash flow and a well managed balance sheet, and CAT has both.
CAT has under performed in the market recently because it was way over bought and, as noted in the Valuentum article that is mentioned above, it faces the headwinds of economic slowing in almost all of its markets and product lines.
CAT is the only stock I have that I won't sell, regardless. I'm a CAT Brat. Dad earned his first CAT stock options many decades ago.
Instead, I trade very out of the money covered calls and sell deep out of the money puts on it. Generally, the strike deltas are around + an minus .10. That means there is about a 10% chance that the call options will be called or the put options will be assigned to me. In other words, there is about a 10% chance that I will have to buy back the options so that i don't lose shares when they are about to be called, and I won't have to buy back puts if the price of CAT's stock falls below the puts options strike and puts me at risk having shares assigned, or sold, to me.
Here are my recent and expiring CAT covered calls and sold puts trades. The delta indicates the probability that a stock will be called or put. On most stocks, I trade the same number of option shares as I own in the underlying stock. I trade parts of my CAT holdings over time rather than all at once, which is another way to diversify risks.
2.13.19. CAT $133.51. Sold CAT March 1 (16 days) $143 strike (.09 delta) covered calls @ $0.27 per share. Immediate return on risk 0.20%. Uncalled annualized ROR 4.56%. Called ROR 166.71%. Dividend plus call premiums 7.13%. Options expired worthless and at a profit.
2.26.19. CAT $137.35. Sold CAT March 8 (10 days) $145 strike (.11 delta) covered calls @ $0.33. Immediate ROR 0.24%. Uncalled annualized 8.77%. Called annualized 212.06%. Options expired worthless.
3.4.19. CAT $138.58. Sold CAT March 15 (11 days) $147 strike (.08 delta) covered calls @ $0.19. Immediate ROR 0.14%. Uncalled annualized 4.55%. Called annualized 206%. CAT closed today at $133.69. The options will expire worthless Friday. I'll write March 29 calls Monday.
3.11.19. CAT $133.04. Sold CAT March 22 (11 days) $140 strike (.10 delta) covered calls @$0.23. Uncalled annualized 5.74%. Called annualized 179%. Given market conditions, I doubt CAT will be in danger of being called next Friday.
Until now, I haven't sold CAT puts because I don't want more shares. But, I have the cash to buy the shares if they are assigned. And if assigned, I might make money on the additional shares or wait for a chance to sell them. So I did this puts trade, too. Selling puts is a bullish trade.
3.11.19 CAT $132.97. Sold CAT April 18 (38 days) $115 strike (-.06 delta) puts. The puts strike was 13.5% below the stock price when the trade was made. Unassigned annualized ROR 2.74%.
Note that I'm trading weekly calls, not monthlies. That reduces my risk because I have a better feel for the "CAT market" over next one or two weeks than for the next 30 to 45 days. Also, I'm trading 38-day puts at big discounts because I don't want to buy more shares. A 2.74% ROR annualized on sold puts almost doubles my dividend yield. The combination of sold calls and puts plus dividends gives me annualized income of 9% to 12%, which meets my goals for CAT.
Again, I trade cautiously most of the time and especially when I'm messing with my CAT shares, which I don't want to sell or buy.
Disclosure: I am/we are long CAT, Short cat calls, puts.
Additional disclosure: Beware: I am an individual speculator and trader for only my family's accounts. I am not an academic, portfolio manager, financial advisor, stock broker or analyst. This article is for the information and amusement of readers who are expected to do their due diligence and make sure that they know what they're doing when they begin to trade stocks, bonds or stock options. This article is not intended to be read as advice of any kind. Trading and speculating are risky, and trading options is more risky than trading stocks. I reserve the right to open or close trades at any time without disclosures or forewarnings.