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Short-Term Bulls Anticipate a Quick Rally For Caterpillar Inc. (CAT)

CAT experiences news-driven spike in call volume

by 7/1/2013 2:01 PM
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Caterpillar Inc. (NYSE:CAT) has agreed to purchase Johan Walter Berg AB, including its Berg Propulsion division, for an undisclosed sum, meaning the company will now offer complete marine propulsion package systems, as opposed to just engines. With that being said, today's call volume for CAT has spiked 42% above the intraday norm. Specifically, 12,000 calls have crossed so far, compared to 6,263 puts.

The majority of these bullish bets took place at the weekly 7/5 85-strike call, where 4,557 contracts have changed hands for a volume-weighted average price (VWAP) of $0.14. Of these contracts, 82% went off at the ask price, implied volatility was last seen 6.8 percentage points higher, and volume exceeds open interest, suggesting buy-to-open activity.

By purchasing these out-of-the-money calls, today's options players expect CAT to rally at least 2.5% from its current perch of $83.10, to finish ahead of the breakeven price of $85.14 (strike price plus VWAP) by this Friday's close, when the weekly option expires. This represents territory last reached on June 19.

Considering CAT has dropped nearly 7.5% year-to-date, and has trailed the broader S&P 500 Index (SPX) by 5.7 percentage points, delta for this option currently sits at 0.17, or 17%, giving it a less than 1-in-5 chance of finishing in the money. Therefore, should the stock fail to surpass the 85 strike, today's call buyers stand to lose the initial premium paid per contract.

From a broader sentiment perspective, CAT speculators have bought to open almost two puts for every call within the past two weeks, resulting in an International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) 10-day put/call volume ratio of 1.88. This ranks in the 100th percentile of its annual range, conveying speculators are more put-heavy now than they have been any other time throughout the year.

Still, the brokerage bunch has remained bullish toward CAT. In fact, 12 of the 19 analysts weighing in on the stock have endorsed it as a "buy" or better, while seven give it a "hold" rating, and zero consider it a "sell" or worse. Likewise, the average 12-month price target of $96.90 represents expected upside of 16.6% to CAT's current price, and sits in territory not charted since mid-February. A round of downgrades and/or price-target cuts could exacerbate selling pressure on the underperformer.


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