Trade Update March 18th, 2013 at 11:30am: Since initiating the April / June Put Calendar (detailed below) on March 8th, TOL hsas fallen about 4%, and the spread is basically unchanged. While this may sound like a decent result, it was not the intended one. I chose the at-the-money strikes with little delta exposure as I felt the stock would likely base in and around $35 as my sense was the market would trade sideways into quarter end. My thesis in TOL remains intact. I believe home-building stock valuations reflect a good bit of the housing recovery, but what I am unsure of is that i have the proper trade structure to benefit from a Q2 re-tracement in the shares.
The April/ June 35 Put Spread with the stock at 33.81 has a positive delta of 10, meaning that I essentially have long exposure at the moment, which I don’t want. So I am going to close the position and re-evaluate. My timing for an at-the-money calendar was obviously wrong. I will look for a better entry point for a short biased trade.
Action: Sold to Close TOL ($33.80) April / June 35 Put Spread at 1.00 for a 0.05 loss.
[hr]
Original Post March 8th, 2013: New Trade $TOL: Trying To Fade This Housing Recovery Is Taking Its $TOL On Me
We have spent our share of time on the site of late debating the strength of the housing recovery and the ability for some of the homebuilders to increase earnings at a pace that would justify existing valuations. On Feb 20th, TOL’ reported disappointing fiscal Q1 results that missed expectations on earnings, sales, gross margins and deliveries. Following the results, the stock got drilled to the tune of 9%, and has failed to make a new 5 yr high as the XHB did today. Prior to the conference call, Enis had the following comments:
7:43 AM EST – FEBRUARY 20, 2013 BY ENIS
Toll Brothers reported an earnings miss this morning, reporting 0.03 vs. consensus estimates of 0.10. The housing sector is one of the most overvalued sectors in the U.S. stock market, for several reasons. Here are 3 brief points on why I’m bearish on TOL and U.S. homebuilders as a whole:
1) This is a housing recovery, not a housing boom. The housing market has clearly improved in the past 12 months, but TOL’s current selling pace in its communities is still below its 25 year average2) Meanwhile, the stock is priced for more than a boom. The stock is trading at 2005 levels, when the stock earned more than $4 per share. In 2013, it’s slated to earn around $1.3) Relative valuation for other sectors much better than homebuilders like TOL. If you want to get long the U.S. housing market, buy Toyota or Ford.On a more macro basis, building has gotten very optimistic in the past 9 months, while the actual pace of sales has been more tepid. As this Business Insider article from yesterday points out, housing completions are rapidly outpacing housing sales in the past year:
A couple weeks ago I bought an April 27/25 Put Spread in the XHB, for largely similar reasons as Enis’ post above, which in hindsight was ill timed. One lesson from this losing trade was that I tried to pinpoint a few weeks where I thought the XHB would make a top and reverse. Trying to pick tops in this market has proven to be a fools errand, and our strategy of late has been to look to get time and decay working in our favor though in the money butterfly’s and calendars (read CC’s post from today explaining this strategy here).
MY VIEW: Maybe I am just fighting just a bit to hard, and I swear I am not being contrarian for the sake of being contrarian, BUT I just don’t see the upside to committing new capital to equities, many of which are trading at all time highs, and most of which are trading at or new 5 year highs. The employment data this morning certainly confirms the notion that we are in an economic recovery, but unless we see some meaningful earnings growth this year, equities could be priced for perfection in what will be a bumpy road to economic health that doesn’t rely on the money printing that exists by central banks the world over.
Most people that I know and speak with are not seeing their investment accounts back to peaks, their homes are still under water, they are working harder for less with higher taxes and austerity all around. I get the argument for the recent housing recovery, rates have been at historical lows and inventories depleting, but this could have been the result of an extremely depressed market that was wound like a coiled spring. Housing could continue to improve at a slower pace off of the bottom, but the likelihood of companies like TOL getting back to peak earnings anytime soon is not great.
Again to reiterate, TOL trades at ~38x this years expected earnings vs the ~8x 2006 earnings it traded last time the stock was ~$35 in mid 2006. Something has to give here, and fiscal Q2 earnings could be the very catalyst that could put a cap on housing stocks for the balance of the year if the company does not see material fundamental improvements to earnings and margins.
I WANT TO OWN PUTS FOR JUNE EXPIRATION, BUT NOT SIT WITH THEM IN A LOW VOL ENVIRONMENT. Given TOL’s recent under-performance to the sector and the broad market, I want to look for ways to take advantage of what could be a range bound market until quarter end, and set up to own puts a bit further out. Near the money calendar spreads should perform well in this low vol environment.
TRADE: TOL ($35.20) Bought April/June 35 Put Spread for 1.05
-Sold 1 TOL Apr 35 Put at 1.35
-Bought 1 TOL June 35 Put for 2.40
Break-Even on Apr Expiration:
-My max risk is the 1.05 in premium I paid for the spread, but the spread basically is flat deltas so large price movements will not affect the value too much in the near term unless there is a dramatic move higher or lower.
– My ideal situation would be for the stock to be at or slightly above 35. At that point I will look to spread the June 35 Puts in front of earnings that should fall in late May.
Trade Rationale: As was the case in CAT the other day (here), I want to get short, but I am not yet ready to go all in and get outright short single names as I think a sustained correction will take some time to evolve and I want to sell shorter dated premium to finance the purchase of longer dated.