Buying options is a way to increase the leverage on a trade, as it takes an investor less out-of-pocket money to gain significantly higher exposure to a stock's underlying direction. The caveat lies in the investor being right on both the direction and timing of the stock since options have an expiration date.
For these reasons, when investors spot unusual options activity, it typically means that traders — and the market — know something about a stock before Main Street does. Three stocks recently reported unusual call option buying activity, meaning a good number of traders bet on these names heading higher soon: Kinder Morgan Inc. (NYSE: KMI), Shell (NYSE: SHEL), and Caterpillar Inc. (NYSE: CAT).
It’s a Manufacturing Year
Goldman Sachs analysts expressed their expectations for a manufacturing sector breakout this year, a thesis found in the bank’s 2024 macro outlook report. Investors can see this thesis play out by following the trends behind the PMI index of ISM manufacturing.
After contracting for over a year, the index finally pushed out its first expansionary reading in March 2024, a trend that Wall Street expects to continue for the rest of the year. As the Fed is looking to cut interest rates later this year, traders expect that manufacturing stocks could be the first to take off.
Why? Lower rates could weaken the dollar, making American exports more attractive to foreign nations. February’s PMI reported a 6.4% boost in export orders. Now, to fulfill these orders, manufacturing names need to get started on production.
Manufacturing activity calls for two things: an ample oil supply and sufficient machinery. This is why oil prices have headed higher recently, breaking their $80 a-barrel ceiling and leading traders to bet on these three stocks.
Banks Like Caterpillar Stock, So Do Markets
Again, Goldman Sachs boosted Caterpillar’s stock valuations to $408 a share, calling for up to 20% upside from where the stock trades today. Following suit, JPMorgan Chase analysts see a target of $435, suggesting a higher ceiling of 27% higher.
[content-module:CompanyOverview|NYSE:CAT]Compared to peers in the construction machinery industry, Caterpillar stock commands a premium in its price-to-book (P/B) multiples. Valued at 9x P/B, Caterpillar is 309% above the industry’s average 2.2x valuation today.
Markets must have a good reason to overpay for this stock, and so do analysts as they boost their valuation targets for the company. Price action would show investors that momentum is on Caterpillar’s side, raising the profit probabilities for these options traders.
Over the past 12 months, Caterpillar has outperformed other industrial stocks. Compared to the Industrial Select Sector SPDR Fund (NYSEARCA: XLI), Caterpillar rose 32.5% above the rest of the sector.
Oil Companies Back in Play
[content-module:CompanyOverview|NYSE:KMI]Attempting to make a new 52-week high, Kinder Morgan stock’s momentum justified a breakout in call option buying. At the same time, short interest for the stock declined by 2.7% over the past month, a sign that bears could be on the retreat as the stock attempts to go on a new bull run.
Beating its peers in the energy sector by close to 5% in the past six months, Kinder Morgan stock could keep outperforming on rising oil prices. Geopolitical tensions help the stock’s sentiment and potential to report better-than-expected earnings in the next quarter.
[content-module:CompanyOverview|NYSE:SHEL]Following in the same footsteps, Shell stock saw up to $4.1 billion in institutional inflows over the past year, showing investors that Wall Street is on board with an oil breakout sponsored by a manufacturing comeback.
Shell stock is also flirting with a new 52-week high and could reach prices not seen since 2018. Bears are attempting to slow the stock down, as short interest rose by 30% in the past month. However, the net short percentage remains below 1%, meaning these attempts could be futile.
[content-module:DividendStats|NYSE:SHEL]More than that, Shell’s 3.8% dividend yield gives investors an inflation-beating income through these rising volatility index (VIX) periods, backed with the fundamental thesis of higher oil prices reiterated by call option traders bet on Shell’s rally shortly.