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Behind the Million Dollar Bet on Caterpillar

Tuesday, 14 May 2013 | 7:07 AM ET
Daniel Acker | Bloomberg | Getty Images

It is a million dollar bet that Caterpillar will move more than 6 percent higher by June. And it could be telling us that traders have not lost faith in this underperforming giant.

Caterpillar shares have had a very tough year, dropping nearly 2 percent as the Dow Jones Industrial Average, of which it is a component, rose by 15 percent. Global growth difficulties and a hard year for commodities have weighed on the construction and mining leviathan. But one trader is not yet giving up hope.

On Monday morning, on option trader bought 15,000 June 92.5-strike calls at a price of 93 cents per share. This is a bet that Caterpillar will be above $93.43 by June expiration. And since each call corresponds to 100 shares, this trader laid out nearly $1.4 million to make this trade.

However, it is worth noting that the trader is doing this while selling 15,000 May 90-strike calls. According to Mike Khouw, primary strategist at DASH Financial, the trader was selling these calls back after buying them at about 50 cents on May 6.

Selling back calls while buying back higher-strike calls of a later expiration is known as "rolling" one's calls, and it is a way for a trader to extend a bullish bet that has not yet paid off.

"Somebody made a bullish bet on May 6, and it was not a bad bet," Khouw said. "It looks like they are now pressing that bullish bet by rolling those calls."

Since these calls would expire worthless on Friday, the trader had to do something.

"This makes sense," Khouw said, "because the May calls expire this week and are now decaying quite rapidly." In other words, as the calls get closer and closer to expiring, time is eating rapidly into whatever still exists of their value.

In total, this trader exchanged 30,000 calls on Monday. That translates into nearly half of Caterpillar's total call volume for the day.

Investor Hairball in CAT?
Stocks are rallying, so why isn't Caterpillar? Could it be that the stock's failure to rally is a warning for stocks? It's time to watch Caterpillar, with CNBC's Melissa Lee and the Options Action traders.

Meanwhile, on Friday's "Options Action," Dan Nathan of RiskReversal.com took the opposite view on Caterpillar. Believing that a strong dollar will continue to hurt the stock, Nathan made a bearish bet. Specifically, he advocated buying the July 87.5/80 put spread for $2.15.That trade will make money if Caterpillar is trading below $85.35 at July expiration.

Only time will tell which of these traders will be in the green — and which will be constructing another trade as they continue to mine for profits.

— By CNBC's Alex Rosenberg. Follow him on Twitter: @LilRosenberg

Follow Options Action on Twitter: @CNBCOptions

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