Options Update: Puts Spike on Caterpillar on Negative Construction Spending Report

Shares of blue-chip industrial construction equipment firm Caterpillar
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have dropped more than 4% so far today, pacing declines in the broad market.

Adding to CAT’s woes, the American Institute of Architects (AIA) said that spending on U.S. nonresidential construction projects will fall during the next 2 years, as builders delay or cancel plans for hotels, office buildings, and retail facilities.

“This is not expected to turn around anytime soon, and it’s likely to get worse before it gets better,” AIA Chief Economist Kermit Baker said in a statement.

Against this backdrop, options traders have turned toward put options en masse. Specifically, more than 14,600 CAT puts have changed hands today, easily doubling the stock’s average daily put volume. Furthermore, this spike in volume has placed the shares on our Intraday Volume Explosion List. However, it was the more than 5,000 contracts that traded at CAT’s February 39 strike that caught my eye today.

Caterpillar option volume details

The Anatomy of a Caterpillar Put Position

Wading into the fray, I noticed that the majority of today’s February 39 put volume has traded at the ask price. What’s more, this activity has easily outpaced open interest at this soon-to-be front-month option, indicating that we could be witnessing buy-to-open trading on CAT. As such, I will be running with a put-buying theme this afternoon.

Digging into the data, I noticed that a block of 100 CAT February 39 puts traded at the ask price of $3.65 at 10:23 a.m. Eastern time. The total outlay for this position would be $36,500 — ($3.65 * 100)*100 = $36,500. For this trade to reach breakeven, CAT would need to fall about 8.81% to $37.75 per share from the stock’s Tuesday close of $41.40 before the options expire on Friday, Feb. 20. The maximum loss on this position is limited to the initial investment of $36,500.

By entering this trade, the investor is indicating that he expects CAT to drop sharply during the next couple of weeks. The position is off to an excellent start, as the equity has fallen more than 4% so far today. That said, let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

The stock’s technical backdrop offers some support for a February 39 put position, given CAT’s poor price action during the past several months. In fact, the shares have plunged more than 51% since setting a near-term peak near $86 per share in late May 2008. During this time frame, the security has met with resistance at its falling 10-week and 20-week moving averages. Currently, CAT is in the process of rolling over from resistance at the latter of these intermediate-term trendlines, breaching former support at the round-number 40 level in the process. The combination of the stock’s 10-week moving average and the 40 level could force CAT to resume its long-term downtrend in the coming weeks.

Weekly chart of Caterpillar since May 2008 with 10-day and 20-day moving averages

There is one caveat to this nearly picture-perfect bearish technical setup, CAT’s 160-month moving average. The shares are hovering just above this long-term trendline, which provided support in October 2002 and has held CAT’s decline in check during the past 3 months. With the 160-month hovering just north of the 37 level, a February 39 put trader could still realize a profit (albeit a small one) if CAT begins to consolidate into this area of support.

Monthly chart of Caterpillar since September 2002 with 160-month moving average

The Sentiment Drivers

On the sentiment front, CAT’s indicators are somewhat mixed, but could still work in favor of a February 39 put. For instance, options traders are betting heavily in favor of CAT, as its Schaeffer’s put/call open interest ratio (SOIR) of 1.18 ranks below 72% of all those taken during the past year. Should CAT continue its recent decline, it could disillusion these bulls, potentially creating an influx of selling pressure as a result.

Elsewhere, short interest accounts for about 4.6% of the stock’s float. While 27.5 million CAT shares sold short could provide for a modicum of short-covering support, these bearish investors appear to be in no rush to buy back their positions. Quite the contrary, as the number of CAT shares sold short has risen about 7% during the past month. If this trend gains traction, it could increase selling pressure on CAT.

Finally, Wall Street analysts also bear mentioning. Currently, only 2 of the 17 brokerage firms rate CAT a “sell,” according to Zacks. This configuration leaves plenty of room for potential downgrades from the brokerage community.

Sentiment indicators for Caterpillar

The Verdict?

Despite the potential for technical support, and some anecdotal bearish sentiment among analysts and short sellers, there appears to be a good case for placing a bearish trade on CAT. The February 39 put is positioned nicely at the moment, especially if the recent round of negative earnings and economic data provides additional downside pressure to the security. Investors should keep a close eye on potential support at the stock’s 160-month moving average, as a breach of this region could result in an extended decline for CAT.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.