Trade Update April 16th, 2012 at 12:50pm:
With TOL up 2.5% on an analyst upgrade from KeyBanc, and 60-day implied vol near the highs of the year, we think it’s a good opportunity to take some premium off the table in our long TOL, short PHM pair trade. TOL is unchanged since we recommended buying the June 26 calls for 0.75 on March 22nd, while PHM is down 5% in that period, but time decay has caused those TOL calls to move about 0.20 lower. However, implied vol has actually picked up in the past couple weeks, shown by this chart of 60-day implied vol in TOL:
Since we are short a $2 wide call spread in PHM (Jul 10/12 at 0.44), we would like to match up our TOL trade to provide similar risk/reward, but with hopefully a higher chance of ending in the money given the recent outperformance. Selling the June 28 calls in TOL at 0.15 allows us to have the June 26/28 call spread on for 0.60. Our new position looks like this:
TOL ($23.45) Bought the June 26/28 Call Spread for 0.60.
-Bought 1 June 26 call at .75 and
-Sold 1 June 28 call at 0.15
The idea here is that we are now long a TOL June 26/28 call spread for 0.60, and short the PHM July 10/12 call spread for 0.44, so our premium at risk in case both spreads finish out of the money is now lower. TOL still has a stronger fundamental case than PHM, but we’re more nervous about a broader market selloff making all the calls worthless.
Trade Update March 22nd, 2012 at 12:30am From DAN: I want to take the opportunity to adjust this trade structure a bit, taking into account the different prerogatives of many of our readers. Very infrequently, if ever, have you seen us sell naked calls, and to be honest I am not sure this is a great time to start given the potential of pent up M&A demand if the economy is truly recovering and if the stock market continues in a bull fashion. So if you agree with the thesis laid out below for what could be a tale of 2 housing developments, I mean cities for the 2 home builders below, than I think the prudent thing to do would be to buy a higher strike call in PHM against the July 10 call that you are short. This would be a short call spread that looks like this:
PHM ($9.13) Sold the July 10/12 Call Spread for .44
-Sold 1 July 10 call at .64 and
-Bought 1 July 12 Call for .20
Basically now your risk is capped btwn the difference of the 2 strikes less the premium that you sold. So your max loss would be 1.54, but you are using the .44 to finance the purchase of the TOL Jun 26 call.
I guess the point is, we are bound to make little mistakes everyday in trading, lets try our best to avoid the big ones that put you out of the game for a bit, so we always cover our wings, it is one of the main reasons we use Butterfly’s a lot, as opposed to 1×2 ratio spreads, in my old life I would have usually saved the premium on the wings as my risk budget was much greater, but for the people out there (including me) it makes sense to buy a little insurance every so often.
Another quick point, if you agree with the thesis, there are other many ways you can express this view so lets think on it a bit, and feel free to write in your ideas.
Original Post March 22nd, 2012 at 10:19 am from CC: Toll Brothers (TOL) vs Pulte (PHM)
TOL vs. PHM
Housing has been a sector of focus to start the year given the rocket start after many years of depressed sentiment and share prices. Similar to the idea that we mentioned in the RF write-up earlier this week, all shares in the sector have been lifted when there are some significant stock specific differences within the sector. First off, as demonstrated by this week’s housing data, multi-family has consistently been stronger than single-family. Geographic and socioeconomic variances have also had a market specific impact. The varying business trajectories of Pulte and Toll Brothers provide a good example of these trends.
Let’s look at the words straight from the most recent management commentary for PHM from their 10-k dated 2/19/12:
The U.S. housing market and broader economy remain in a period of uncertainty. While we have experienced some stabilization in our local markets, homebuilding industry volumes remain at near historically low levels. This more stable environment has resulted in a significant reduction in the level of land-related charges recorded during 2011 compared with recent years. However, significant short-term uncertainty remains such that we are not anticipating a broad recovery in homebuilding in the near term…Our outlook is cautious for 2012 as the timing of a sustainable recovery in the homebuilding industry remains uncertain.
A much different message is evident from the management commentary for TOL in their latest 10-Q filed March 8th, 2012:
We continue to believe that many of our markets and housing in general have reached bottom; however, we expect that there may be more periods of volatility in the future. We also believe that our target customers generally have remained employed during this downturn, but that many have deferred their home buying decisions because of concerns over the direction of the economy and media headlines suggesting that home prices continue to decline…We also believe that the medium and long-term futures for us and the homebuilding industry are bright…Although, historically, our first fiscal quarter is the most challenging time to gauge sentiment among home buyers, in general, the market feels healthier to us than it did in the comparable period of fiscal 2011.
TOL management’s actions have followed their words, as they purchased CamWest last quarter and have increased owned land and community inventory over the last year to take advantage of a nascent recovery.
Moreover, while TOL focuses on housing communities, PHM is quite concentrated in single family. Again from the PHM 10-K:
Sales of single-family detached homes, as a percentage of total unit sales, were 79% in 2011, compared with 79% in 2010, 77% in 2009, 75% in 2008, and 74% in 2007.
YTD price performance for PHM is about 40%, while TOL is up about 15%, and while PHM was certainly the more beaten down of the two, the commentary above and their respective inventory situations indicate that TOL sees the light at the end of the tunnel and might be close to exiting but PHM is still mired in a downturn. What’s striking as well though is that after this year’s move, PHM Price-to-Book now trades above TOL P/B, an important metric for homebuilders with significant unsold inventory.
We see this as another opportunity to fade the outperformance, so here’s the trade we did:
TRADE: TOL (23.90) PHM (9.13)
Sell the PHM Jul 10 calls for 0.65
Buy the TOL Jun 26 calls for 0.75
This trade takes advantage of the higher implied vol level in PHM and also gives the trade one more earnings cycle to work, given our thought that the fundamentals should reassert themselves by that time. Moreover, TOL implied vol is not far from last year’s low spring levels while PHM implied vol has remained more elevated, so we prefer to buy premium in TOL and sell premium in PHM.
TOL implied vs realized:
[caption id="attachment_9934" align="aligncenter" width="630" caption="TOL HV vs IV from LiveVol Pro"]
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PHM implied to realized:
[caption id="attachment_9935" align="aligncenter" width="630" caption="PHM HV vs IV from LiveVol Pro"]
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