Cummins' Earnings Selloff Won't Last -- Here's Your Trading Strategy

Cummins  (CMI)  shares slumped Tuesday after the company reported quarterly results. Technical analysis suggests the stock will bounce back, however, and savvy investors can profit from such a move using stock options. 

Shares fell 4.3% to close at $122.29. Although the company reported adjusted earnings per share of $2.02, beating the Wall Street consensus for $1.93, revenue fell 9% year over year to $4.2 billion and missed analysts' expectations for $4.26 billion.

The chart shows that Tuesday's decline marked a gap below the established support line. That means the stock is likely to reverse higher and trade at more than $124 again. 

An advantageous options trade would be to sell short a put option. This trade has the same market risk as a covered call. With the stock's price expected to rebound above $124, look at the Nov. 11 options, which expire in 10 days.

The 122 put option closed on Tuesday at a bid of 2.00. Subtracting trading costs, this trade would net $191. With only 10 days to expiration, expect rapid time decay. This is a 1.6% return in only a few days.

If the price ends up in the money (less than $122 per share), this short put can be closed or rolled forward to avoid exercise. As long as the stock's price remains at or above $122, the option will expire worthless in 10 days.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

Besides blogging at TheStreet.com, Michael Thomsett also blogs at Options Money Maker, the Top Advisor's Corner at Stockcharts.com, and Seeking Alpha. He has been trading options for 35 years and has published books with Palgrave Macmillan, Wiley, FT Press and Amacom, among other publishers. He is working on a new book on options math, to be published by Palgrave Macmillan in 2017.

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