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Long-Term Caterpillar Inc. (CAT) Trader Gambles On a Steep Slide

Caterpillar Inc. was targeted for a bear put spread today

by 5/7/2014 3:12 PM
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Although Caterpillar Inc. (NYSE:CAT) has tacked on nearly 15% in 2014 -- led higher by its supportive 20-day moving average -- the equity sports a 50-day put/call volume ratio of 1.76 on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). Not only does this show that nearly two puts have been bought to open for each call over the past 10 weeks, but it ranks in the 95th percentile of its annual range. In other words, long puts have been initiated over calls at a faster clip just 5% of the time within the past year.

It's a similar set-up to today's trading, where puts are outpacing calls by a margin of more than 2-to-1. Diving deeper, it appears one speculator is betting on a steep slide for the Dow component over the next six-plus months, but is reducing her risk/reward profile by initiating a two-legged long put spread in the November series of options. Specifically, in early trading, one block of 2,500 November 80 puts was sold at a bid price of $0.67 each, while a symmetrical block of November 90 puts was simultaneously bought near the ask price at $1.85 apiece, resulting in a net debit of $1.18 per pair of contracts. Volume exceeds current levels of open interest at each strike, indicating the initiation of new positions.

The expectation for establishing this bearishly biased strategy is for CAT to be at or below $80 at the close on Friday, Nov. 21 -- when the options expire. The trader can then pocket the full potential reward of $8.82 (difference between the two strikes less the net debit), as the bought puts will achieve their maximum potential profit as part of this spread, while the sold puts will be left to expire worthless. However, the speculator will still be able to profit as long as Caterpillar Inc. (NYSE:CAT) lands below breakeven at $88.82 (bought strike less net debit) -- a level that resides almost 15% below the equity's current price of $104.21. Risk, meanwhile, is limited to the initial cash outlay, or $295,000 (2,500 contracts * net debit * 100 shares per contract) in the case of today's spread strategist.


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