Emerging options in play: Caterpillar


As the global market continues to push higher, some large-cap names are becoming interesting ideas for traders looking to add options to a standard long-only portfolio. Looking at the VIX, we are seeing continued pressure on volatility as this volatility-driven index seems to have found a range between 20 and 25 -- well off the nosebleed-inducing 45 it touched during the May euro crisis.

The 200-day moving average currently 23.5 and is trending sideways, which according to the Stutland Volatility Group bodes well for a market that could hold this range and continue its current uptrend. This, in turn, makes stocks like Caterpillar CAT interesting, Stutland analysts say.

Caterpillar: in position

CAT is a stock that looks well positioned to take advantage of domestic infrastructure initiatives and continued booming construction in places like Brazil. Given bullish momentum for the S&P 500 SPY as a whole, this a solid industrial stock that appears to be well positioned for further upside -- and more than half of its revenue already comes from overseas, so it is highly leveraged to emerging markets growth.

The stock is currently trading at around $78.15. If you think the stock can move higher, you can buy 100 shares at $78.15 and also sell the January $85 option (currently priced at $2.38) that obligates you to sell 100 shares at $85 in January. If you buy 100 shares at $78.15 apiece and sell 1 January 85 call for $2.38, you can potentially realize a gain of 11.8%.

Writing the January 85 call allows you to collect 3% premium on the stock. If the stock trades between 78.15 and 85 at January expiration you will collect the 3% premium on the option write, plus the accumulated value of the stock. Your breakeven on the spread is 82.62. If CAT rises, but remains below $85, your option entitles you to sell your shares that above-market price, netting a return of 8.7%. Add the $2.38 a share you got for your option, and your total return could come to 11.8%.

If CAT rises above $48, you forfeit the extra appreciation, so your total return is capped at "only" 8.7%. However, the covered call should add to your performance as long as CAT stays under $82.62. And if CAT declines, the $2.38 a share you got in cash when you wrote your sell option helps to minimize the downside.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Options , International

Referenced Stocks: CAT , SPY

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