Trade Update Nov 9th, 2012: CMI has shown bizarre strength in the past 2 weeks, diverging from market weakness. That unfortunately hurt my profits on this short call spread position, but at least the stock has come back down to $94, giving me a chance to take a profit on a position that was close to a full loss only a few days ago.
Action: Bought to Close CMI ($94.50 ) Nov 92.50 / 97.50 call spread for $2.20 for a $0.10 gain
-Bought 1 Nov 92.50 call for $2.25
-Sold 1 Nov 97.5 call at $0.05
Original Post Oct 22, 2012: New Trade CMI: Playing for a Selloff INTO Earnings…Again
I traded a short CMI call spread on Oct. 4th as a way to play a selloff into earnings as I expected traders to be cautious given the poor macro backdrop. This is what I wrote on Oct. 4th:
Analysts have not yet capitulated either, with CMI sporting 12 buys, 10 holds, and 0 sells, for a name that has sold off 30% from its highs earlier this year. Valuation seems cheap at 10 times earnings, but it feels like a classic value trap at this point in the cycle.
More importantly, both CMI and CAT have had a tendency to sell off into earnings reports over the past 2 quarters, as investors have gotten more nervous about the fundamental backdrop. That tendency, and the legitimacy of the fundamental concerns, got me interested in option plays.
Expectations seem likely to be quite low by the time CMI actually reports results. You could get a JOY type scenario (JOY reported in late August, weak results, but guidance wasn’t as bad as expected, and expectations were so low, that the stock rallied by the close). However, until the report actually comes out, I think traders will be nervous to buy this dog. So I wanted a trade that doesn’t take the earnings risk, but plays for a selloff ahead of the report
CMI did in fact pre-announce, and I covered my short call spread on the selloff the following day, on Oct. 10th. Interestingly enough, CAT did sell off into earning as usual, and is rallying today despite the bad news, since the bad news was priced in. But CMI is also rallying hard today, and is up 8% from the lows it made on Oct 11th, two days after the pre-announcement news.
Now I feel like we’re back in a scenario where risk/reward is again skewed for a selloff into CMI earnings. Again, the news will be bad, and this recent rally gives traders gains to close out before the bad news hits. CMI reports earnings on Oct 30th, so I am going to play for a move lower in the next week, and plan to take the trade off ahead of earnings again.
TRADE: CMI ($94.25) Sold to Open the Nov 92.5 / 97.5 call spread at $2.30
- Sold 1 Nov 92.5 call at 4.10
- Bought 1 Nov 97.5 call for 1.80
Break-Even on October Expiration:
- Profits btwn 94.80 and 92.50, with max profit of $2.30 below 92.50
- Losses btwn 94.80 and 97.50, with max loss of $2.70 above 97.50
I decided to sell a call spread again because I feel more confident that CMI has limited upside from here, rather than that a big down move is coming. The stock stopped near the $95 again this morning, which has served as resistance several times in the last month. The 50-day moving average at 96 is another reference point that makes me think the stock will have trouble shooting higher before earnings on Oct. 30th. So this trade is a way to get a short-biased position with limited risk if CMI does not spike higher in the next week.