Options Trade of the Day: A Bearish Put Spread on Caterpillar Inc.

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The shares of blue chip construction equipment firm Caterpillar Inc. ( CAT ) have been on a tear recently, rallying more than 56% since the start of the year. What's more, CAT has jumped nearly 3% today to tag a fresh all-time high of $92. Despite the stock's record run, options speculators have shown a preference for puts so far today.

Weekly chart of CAT since March 2009 with 10-week moving average

Specifically, more than 10,000 of these typically bearish bets have changed hands on CAT so far today. What's more, this groundswell of put activity more than doubles the stock's average daily put volume of 5,285 contracts. The most popular strike has been the December 90 put, where more than 4,350 contracts have crossed the tape.

Drilling down on the December 90 put reveals a bearish put spread on CAT. Specifically, a block of 100 December 90 puts traded for the ask price of $1.00, or $100 per contract, at about 10:50 a.m. Eastern time on the International Securities Exchange (ISE), suggesting that these contracts were bought to open. At the same time, a block of 100 December 85 puts traded for the bid price of $0.17, or $17 per contract, suggesting that the contracts were sold to open. Both blocks were marked "spread." Given this data, it appears that the trader opened a vertical put spread, or debit spread , on Caterpillar.

CAT option volume details

The Anatomy of a Caterpillar Vertical Put Spread

Breaking down this debit spread position, the trader purchased 100 December 90 puts for the ask price of $1.00, resulting in a debit of $10,000 -- (1.00 * 100) * 100 = $10,000. In the absence of the premium received by selling the December 85 put, the trader would need CAT to drop roughly 2.9% from the stock's current trading range near $91.60, to $89 per share, in order for the position to reach breakeven at expiration. Furthermore, the maximum loss on this leg of the position is limited to the initial investment of $10,000.

As you can see, the second leg of the debit spread helps to offset the cost of the overall position. In this case, the trader sold 100 December 85 puts for the bid price of $0.17, netting a total credit of $1,700 -- (0.17 * 100) * 100 = $1,700. Combining this leg of the trade with the purchased December 90 put lowers the total cost of the entire position to $8,300 -- $10,000 - $1,700 = $8,300.

CAT vertical put spread

CAT profit loss chart

Implied Volatility

After the vertical put spread has been established, rising implied volatility is pretty much neutral to the overall position, as it lifts the value of both the sold option and the purchased option. At the time of the trade, implieds for the December 90 put arrived at 27.31%, while the implied volatility for the December 85 put came in at 31.05%. For a point of reference, CAT's one-month historical volatility was 13.33% as of the close of trading on Monday.



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.

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This article appears in: Investing , Options

Referenced Stocks: CAT

Schaeffer's Investment Research

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