This Trade Targets a 100%-Plus Return in Four Months

Option Trade of the Day: Cummins Inc. (CMI)

Yesterday’s trading action was interesting. After the biggest two-day gain in approximately a year and a half, the market opened lower. However, bulls took control in the early afternoon and the main indices all closed with gains for the third straight day.

[hana-code-insert name=’adsense-article’ /]The scans continue to be dominated by bullish signals, which isn’t surprising after the sharp selloff.

Given the bullish skew of my scans, I have another bullish trade idea for you today.

This time it is Cummins Inc. (NYSE: CMI).

If you aren’t familiar with the company, they design, manufacture, distribute, and service diesel and natural gas engines, and engine-related component products worldwide.

The company has performed extremely well from a fundamental standpoint with an ROE of 25.1% and a profit margin of 11.6%.

The chart for CMI is what really got my attention. Look at the circles and arrows in the four periods. The stochastic readings are in oversold territory each time, the 10-day RSI is in oversold territory each time, and the arrows represent the times when the sentiment reached excessive pessimism. The other three times it has happened in the past year, the stock has rallied at least 14% in the two months after each occurrence.

Buy to open the June18 160 strike calls on CMI at $13.00 or better. These options expire on June 15. If we get a 14.7% gain from the current price, that would put the stock up close to $190 and that would make these options worth at least $30. If you go from the low from last week being down around the $160 mark, it will take a gain of 16.25% for these options to double on an intrinsic basis. I didn’t really want to go all the way out to June with these options, but at this time the April options aren’t available and I wanted to make sure we had at least two months before the options expire. These options give us four months worth of time.

— Rick Pendergraft

OPTIONS DISCLAIMER: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation,

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Rick Pendergraft, Trades Of The Day

Rick Pendergraft has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick's analysis process includes fundamental, sentiment and technical analysis.