Caterpillar (CAT): Playing the Breakdown Re-Test and a Look into My Trading Process

One of the most common technical moves comes via the "re-test", whether it is a stock in an uptrend that breaks out of consolidation and then eventually comes back down and re-tests that level, or a stock that breaks key support, but then sees a bounce back to test that level. These generally come on lighter volume than was seen during the breakout/breakdown move.

A recent example that Options Hawk members capitalized on was with Caterpillar (CAT). Shares broke key support at $95 in early August and fell all the way to $80, which happened to be a re-test of the November 2010 breakout, a suitable support level for a bounce. Shares then bounced on decreasing volume over a few days and ran back up to $92.80, nearly a re-test before fading once again. I missed entry on that move, but then shares came back to $80 and proceeded to bounce on light volume to $93.80, just below the 50 day EMA which recently had a bearish cross of the 200 EMA, a Death Cross, so the intermediate trend was bearish and favored a move lower from that level.

I also felt better about this set-up by following the options action. On August 26th I pointed out a buyer of 5,600 October $87.50 puts on the $8.30 offer to subscribers in our members only chat room, a large bearish bet.

I track the high impact option trades and sentiment for all stocks I am watching on various spreadsheets I created for members, so when I saw this move in CAT I knew it was an opportunity to get those puts at a price well below where the Institutional Trader put on the position, which is what I often look for, either a break of a key price level to follow the smart-money or via a spreadsheet I created that tracks current option prices versus the price where a big block traded in recent days or weeks.

We added the CAT Oct. 87.50 puts at $3.60 on August 30th and took profits this morning at $8.50, a sweet 136% gain for a position we only had on for 2 trading days!

I track unusual and large options action for idea generation, always having a list of bullish/bearish sentiment names to look at depending on how the market is acting, and where I see it going. I also use this along-side basic Technical Analysis with price patterns, EMAs, and momentum indicators for the directional trades. I also put some weight into the fundamental view, and recent earnings from Joy Global (JOYG) were unimpressive in my view, despite the initial 6% pop in shares (later faded hard), and although CAT is a clear value and great Company, the outlook has been based on strong China growth, which is softening.

CAT Chart Below with Key Levels: