Things are firing on all cylinders at HD, the stock clearly reflects the strong fundamentals, up today about 4.5% after a beat and raise and up ~52% on the year. The company has been a clear beneficiary from the perceived housing recovery in the U.S., as many investors have used the stock as a proxy.
I want to make a defined risk bearish bet and fade today’s strength, playing for a pull back to support at about $55 over the next few months. Here are a few quick reasons for the view:
Fundamentals:
- This morning’s results and outlook clearly confirm what most investors in the stock have been thinking, but analysts remain a bit more cautious, with 17 Buys, 13 Holds and 1 Sell and an avg 12 month price target of about $62, a % below where the stock is trading.
- Valuation is a tad stretched at about 21x 2013 expected earnings that are only expected to grow 14%, on sales expected to grow 5%.
- The company is executing well in what has been a challenged retail environment, but today’s beat is largely the result of strong expense controls, there is no guarantee the company will be able to maintain this discipline going forward.
- The chart looks very extended, particularly on a long term basis. While today’s break-out is very impressive on large volume, the trade appears to be increasingly crowded. The 5 year chart below reminds me of similar parabolic moves of late from much faster growing tech stocks.
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- On a shorter term basis, the stock seems over bought and could retrace to the $55 support level that appears to be close to the trend channel that it has just broken away from
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Volatility:
HD volatility is in about 11% across all months today following earnings. This makes for a good set-up in the options to play for a reversal in the stock. Feb at the money options are priced at about 20 vol, which historically is near the lower end of where they ever trade:
[caption id="attachment_19369" align="aligncenter" width="490" caption="HD 60 and 90 day Realized Vol vs 30 day Implied Vol from Bloomberg"]
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The options in months like Feb could come down a little more into the high teens if the stock continues to climb, especially if it creeps. But any reversal in the stock means that that 20 vol should hold its value pretty well.
TRADE: HD ($63.75) Bought Feb 62.50 / 55 Put Spread for 1.80*
-Bought 1 Feb 62.50 Put for 2.30
-Sold 1 Feb 55 Put at .50
Break-Even on Feb Expiration:
-Profits of up to 5.70 btwn 60.70 and 55, max gain of 5.70 at 55 or below.
-Losses of up to 1.80 btwn 60.70 and 62.50, and max loss of 1.80 at 62.50 or higher.
Trade Rationale: While outright puts are not particularly expensive in vol terms as described above, the next couple months will see a lot of quiet trading periods with the Holidays, I wanted to use a spread to have some of the decay offset from my long strike. I chose Feb expiration as Jan will decay too fast with Holidays and Feb will catch their next earnings.
*ONE BIG CAVEAT HERE: THIS IS A CONTRARIAN TRADE, AND I AM FIGHTING THE OBVIOUS TREND, I INITIATED THIS POSITION WITH ABOUT A THIRD OF MY NORMAL TRADING POSITION.