Trade CAT with options, here’s how

  • October 21, 2005
  • John F. Summa

Playing the “Dead CAT
Bounce”

Caterpillar Tractor
(
CAT |
Quote |
Chart |
News |
PowerRating) got slammed today
following guidance from the company that future earnings would be down from
current levels, despite beating estimates for Q3. The company lowered its
financial outlook for 2005 and 2006. The stock price dropped $2.78 (5.2%) to
$51.25, in pre-market action, and opened even lower on the NYSE at 49.26, as
seen in Figure 1.

Figure 1 — Generated by
OptionVue 5
Options Analysis Software

With uncertainty surrounding future earnings,
this is a nice setup for a call credit spread, as presented in previous
articles. Figure 2 presents the profit/loss plots for interim time frames and at
expiration (solid line) for a January 55 x January 60 call spread. The spread
collects approximately $60 with a margin required of $440, and has a breakeven
point 11.6% above the level of CAT at the time these prices were taken.
Breakeven is at 55.60 (not calculating commissions).

Figure 2 — Generated by
OptionVue 5
Options Analysis Software

Another way to play this is to wait for a
so-called “dead-cat bounce,” a post gap bounce that often occurs before renewed
selling sets in. That would give you a slightly better entry point. In any case,
apply the stop loss used in previous trades. Close the spread if it doubles, or
if the price rallies back to the “not likely to go zone”, the pre-gap price area
of 54.

Good luck with your trades.

Cheers!

John Summa


John F. Summa is Founder and President of


OptionsNerd.com,
and a registered Commodity Trading Advisor (CTA) with the National Futures
Association (NFA). Founded in 1998, OptionsNerd.com offers trading
seminars and tutorials to options traders, futures and option trading
advisories and managed futures and options CTA account services.

Mr
Summa’s trading articles have appeared in Technical Analysis of Stocks &
Commodities magazine, as well as Active Trader Magazine, Options Trader
Magazine, Futures Magazine, Stock, Futures & Options Magazine, and Investopedia.com. He coauthored


Options on Futures: New
Trading Strategies and Options on Futures Workbook (John Wiley & Sons, 2001) and more recently wrote the groundbreaking
book,
Trading
Against The Crowd: Profiting From Fear and Greed in Stock, Futures and
Options Markets (John Wiley & Sons,
2004), which includes Mr. Summa’s innovative quantitative bear and bull
news-flow Contrarian indicator. Mr. Summa is a PhD-trained economist
and operates a
delta-neutral options trading CTA program.



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