Caterpillar (CAT) Drops After an Earnings Beat … And It’s a Bullish Sign

On Thursday, CAT did something it’s done for the past three quarters – it easily topped earnings estimates. The company reported $2.87 in adjusted earnings versus the projected $1.95. Sales ($11.9 billion) also soared past estimates ($10.5 billion). The numbers were well received by Wall Street, as a couple of brokerages raised their target prices. But analysts overall are less than enthusiastic toward the stock, with more than half rating the shares a hold or sell. That seems at odds with the stock’s performance, however. CAT has more than doubled off a low from last May and is up 25% for the year. The stock should benefit as more analysts come to their senses and jump on CAT’s bandwagon with upgrades.  

Despite the impressive performance and target price increases, CAT is down 2% since earnings. But this is a good thing. Why? For the fourth straight quarter, CAT declined after blowout earnings. But in each of the previous three quarters, the decline was perfectly supported by the rising 50-day moving average. In fact, the stock has closed below this trendline just two times going all the way back to mid-May of last year. The 50-day is currently sitting just above the $226 level. Given the previous post-earnings pullbacks to this support, we’re looking at a credit spread with the short strike below the 50-day.

If you agree that CAT will stay above its 50-day moving average, consider the following trade that relies on the stock remaining above $225 through expiration in five weeks.

Buy to Open CAT 4Jun21 222.5 Put (Cat210604P222.5)
Sell to Open CAT 4Jun21 225 Put (Cat210604P225) for a credit of $0.85 (selling a vertical)

This credit is $0.02 less than the mid-point of the option spread when CAT was trading at $228. Unless the stock rallies quickly from here, you should be able to get close to this amount.

Your commission on this trade will be only $1.30 per spread.  Each spread would then yield $83.70. This trade reduces your buying power by $250 and makes your net investment $166.30 ($250 – $83.70).  If CAT closes above $225 on June 4, both options will expire worthless and your return on the spread would be 50% ($83.70 / $166.30).