CAT Breaks Out

Caterpillar Inc. (CAT) this week broke above a level of congestion that has been in place since late October 2011. An opening upside gap on the daily chart has pushed the price up to 2.9% above the prior day's close, bursting through the Fibonacci 61.8% retracement level.

Caterpillar is a household word, at least if your household is involved in moving dirt and other heavy construction tasks. It is a stock with a great story if economic recovery is at hand.

In slump, the dirt tends to stay where it is. As business activity picks up, then people feel a need to move that dirt elsewhere, and Caterpillar finds a growing market for its machinery.

The current rise is embedded within a retracement of a major decline, from $116.55 in early May 1011 down to $67.54 in early October. Since then, the price has traced a zig-zag back up -- today's high of $99.90 marks the terminus (so far) of a second zig.

That price pattern alone made CAT stand out as I ran a 16-chart bracket whose stocks were picked at random from 184 stocks that have been rated strong buy by Zacks. (See my essay "10,000 Charts" for an explanation of how I use brackets.)

Also in its favor was the fact that the breakout over the past two days has been on rising volume.

CAT has a fair degree of institutional ownership, at 65%, but that's far from being a poster child of professional managers of big money.

But its return on equity is well in growth-stock territory, at 36%. However, it has gone deep into hock in accomplishing that, with a debt/equity ratio of 1.88, well above my level of comfort.

The debt may explain the rather low premium for sshares compared to sales -- the price/sales ratio -- which is only 1.13. That means $1.13 worth of stock buys a dollar's worth of sales. That's close to bargain territory.

For the near term, I don't sweat the debt -- interest rates are at huge historical lows, and now is the time to borrow if borrow one must.

My main concern is the gap, since they tend to be filled in. So if I were to trade CAT, I would want it to be hedged somehow.

Happily for hedgers, CAT is a highly liquid stock, with an average daily volume of more than 6 million shares and a fine selection of options with high open interest. So it's a hedger's heaven.

But -- calendar note -- the stock goes ex-dividend on Jan. 18, so traders might want to have some shares in the mix in order to capture the 46¢ quarterly payout.  (Although it's a small payout: $46 on a 100-share $10,000 position.)

The next earnings announcement is Jan. 26, before the open.

Decision for my account: I shall open a February bull put spread, short the $97.50 put and long the $92.50 put, that is profitable above $96,  or so, a level that allows room to retrace not only today's upside gap but the entire rise of the past two days. I passed on shares because of the small return, and also because that expensive a stock tends to push me above the max position size allowed by trading rules.



Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.