By Jud Pyle, CFA, chief investment strategist for the Options News NetworkDuring the first hour of trading, an investor sold off the upside of Caterpillar ( CAT) stock to decrease the cost of downside protection, using a strategy that is often referred to as a collar. The investor bought the out-of-the-money Nov. 29 puts for roughly $2.97 and simultaneously sold the out-of-the-money Nov. 37 calls 10,000 times for $1.27, netting around $1.70 per spread. The Nov. 29 puts, which changed hands approximately 11,000 times today, traded up 40 cents on the day. Investors traded the Nov. 37 calls, which traded down 38 cents on the day, more than 11,000 times as well. The Nov. 29 puts are home to open interest of 1,000 contracts and the Nov. 37 calls are home to open interest of 1,300 contracts. Normal daily options volume across all strikes in CAT is roughly 45,000 contracts, compared to the 70,000 contracts that have changed hands today. CAT shares traded down $1.45 on the day to close at $30.25. There was not any significant news in CAT today. Rather the stock likely sold off along with the rest of the market. In addition, as energy and base material stocks continue to sink, CAT could be sliding because its main customers operate in that space. CAT has rallied 37% since reaching its 52-week low of $22.17 on March 2, but it is more than 20% off of its recent high of $40 reached on May 6.
This morning, CAT announced it will release its second-quarter earnings figures on July 21 before the market open; analysts expect a 17-cent drop in earnings per share from last year to 22 cents a share. Bullish investors who are long CAT stock might buy the Nov. 29-37 risk reversal for downside protection, suggesting that their bullishness is limited. This is what we mean by giving up the upside to finance the downside protection. Rather than paying the full $2.97 for the 29 puts, investors sell the 37 calls to decrease the cost. Meet Jud Pyle live in Las Vegas at the Forex & Options Expo. Click here to find out more. Jud Pyle is the chief investment strategist for Options News Network and the portfolio manager of TheStreet.com Options Alerts. Click here for a free trial for Options Alerts. Mr. Pyle writes regularly about options investing for TheStreet.com.